Algoma Steel Group (NASDAQ:ASTL) Is Reinvesting At Lower Rates Of Return

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Algoma Steel Group (NASDAQ:ASTL), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Algoma Steel Group:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.06 = CA$136m ÷ (CA$2.7b - CA$441m) (Based on the trailing twelve months to September 2023).

Therefore, Algoma Steel Group has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 9.7%.

Check out our latest analysis for Algoma Steel Group

In the above chart we have measured Algoma Steel Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Algoma Steel Group.

How Are Returns Trending?

When we looked at the ROCE trend at Algoma Steel Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.0% from 22% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Algoma Steel Group has done well to pay down its current liabilities to 16% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Algoma Steel Group have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 21% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Algoma Steel Group (of which 1 is a bit unpleasant!) that you should know about.

While Algoma Steel Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.