If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Alcoa's (NYSE:AA) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Alcoa, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$1.5b ÷ (US$14b - US$2.9b) (Based on the trailing twelve months to September 2021).
So, Alcoa has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 15% generated by the Metals and Mining industry.
In the above chart we have measured Alcoa'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 Alcoa.
What The Trend Of ROCE Can Tell Us
Alcoa has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 502%. The company is now earning US$0.1 per dollar of capital employed. Speaking of capital employed, the company is actually utilizing 25% less than it was five years ago, which can be indicative of a business that's improving its efficiency. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
What We Can Learn From Alcoa's ROCE
In the end, Alcoa has proven it's capital allocation skills are good with those higher returns from less amount of capital. Since the stock has returned a solid 58% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you want to know some of the risks facing Alcoa we've found 2 warning signs (1 is a bit concerning!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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.
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