If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. So on that note, MP Materials (NYSE:MP) looks quite promising in regards to its trends of return on capital.
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. Analysts use this formula to calculate it for MP Materials:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.099 = US$182m ÷ (US$1.9b - US$60m) (Based on the trailing twelve months to December 2021).
Thus, MP Materials has an ROCE of 9.9%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 17%.
Above you can see how the current ROCE for MP Materials compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering MP Materials here for free.
The Trend Of ROCE
The fact that MP Materials is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making three years ago but is is now generating 9.9% on its capital. And unsurprisingly, like most companies trying to break into the black, MP Materials is utilizing 2,400% more capital than it was three years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 3.2%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
What We Can Learn From MP Materials' ROCE
To the delight of most shareholders, MP Materials has now broken into profitability. Since the stock has returned a solid 11% to shareholders over the last year, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you want to know some of the risks facing MP Materials we've found 2 warning signs (1 is significant!) 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.
What are the risks and opportunities for MP Materials?
Trading at 53% below our estimate of its fair value
Earnings are forecast to grow 12.77% per year
Earnings grew by 146% over the past year
High level of non-cash earnings
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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.