MP Materials' (NYSE:MP) Returns On Capital Are Heading Higher

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Speaking of which, we noticed some great changes in MP Materials' (NYSE:MP) returns on capital, so let's have a look.

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. The formula for this calculation on MP Materials is:

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

0.17 = US$339m ÷ (US$2.1b - US$66m) (Based on the trailing twelve months to June 2022).

Therefore, MP Materials has an ROCE of 17%. By itself that's a normal return on capital and it's in line with the industry's average returns of 17%.

Our analysis indicates that MP is potentially undervalued!

In the above chart we have measured MP Materials' 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 MP Materials here for free.

What Can We Tell From MP Materials' ROCE Trend?

The fact that MP Materials is now generating some pre-tax profits from its prior investments is very encouraging. About three years ago the company was generating losses but things have turned around because it's now earning 17% on its capital. Not only that, but the company is utilizing 2,732% more capital than before, but that's to be expected from a company trying to break into profitability. 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 3.1%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

The Bottom Line

To the delight of most shareholders, MP Materials has now broken into profitability. Given the stock has declined 20% in the last year, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we've found 1 warning sign for MP Materials that we think you should be aware of.

While MP Materials 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. 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.