If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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 Kraton's (NYSE:KRA) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Kraton, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = US$89m ÷ (US$2.5b - US$443m) (Based on the trailing twelve months to March 2021).
Therefore, Kraton has an ROCE of 4.4%. In absolute terms, that's a low return and it also 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 The Trend Of ROCE Can Tell Us
While the ROCE is still rather low for Kraton, we're glad to see it heading in the right direction. We found that the returns on capital employed over the last five years have risen by 144%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 26% 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.
In summary, it's great to see that Kraton has been able to turn things around and earn higher returns on lower amounts of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 36% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
Kraton does have some risks though, and we've spotted 2 warning signs for Kraton that you might be interested in.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
If you decide to trade Kraton, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.