The Returns On Capital At Algoma Steel Group (NASDAQ:ASTL) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Algoma Steel Group (NASDAQ:ASTL), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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

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

0.14 = CA$286m ÷ (CA$2.5b - CA$343m) (Based on the trailing twelve months to March 2023).

Therefore, Algoma Steel Group has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 12% generated by the Metals and Mining industry.

Check out our latest analysis for Algoma Steel Group

Above you can see how the current ROCE for Algoma Steel Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Algoma Steel Group.

What Does the ROCE Trend For Algoma Steel Group Tell Us?

When we looked at the ROCE trend at Algoma Steel Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 20% over the last five years. 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 14% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

The Bottom Line On Algoma Steel Group's ROCE

In summary, we're somewhat concerned by Algoma Steel Group's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 15% from where it was year ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Algoma Steel Group (including 2 which are potentially serious) .

While Algoma Steel Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.