What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. In light of that, when we looked at Kraton (NYSE:KRA) and its ROCE trend, we weren't exactly thrilled.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Kraton:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = US$34m ÷ (US$2.4b - US$378m) (Based on the trailing twelve months to September 2020).
Thus, Kraton has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 8.1%.
In the above chart we have measured Kraton's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Kraton here for free.
What Can We Tell From Kraton's ROCE Trend?
The returns on capital haven't changed much for Kraton in recent years. The company has employed 122% more capital in the last five years, and the returns on that capital have remained stable at 1.7%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
In summary, Kraton has simply been reinvesting capital and generating the same low rate of return as before. Since the stock has gained an impressive 82% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Kraton (of which 1 is concerning!) that you should know about.
While Kraton 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. 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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