Capital Allocation Trends At NewMarket (NYSE:NEU) Aren't Ideal

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. In light of that, when we looked at NewMarket (NYSE:NEU) and its ROCE trend, we weren't exactly thrilled.

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 NewMarket is:

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

0.17 = US$360m ÷ (US$2.5b - US$372m) (Based on the trailing twelve months to June 2021).

Thus, NewMarket has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 9.9% generated by the Chemicals industry.

Check out our latest analysis for NewMarket

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating NewMarket's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For NewMarket Tell Us?

On the surface, the trend of ROCE at NewMarket doesn't inspire confidence. Around five years ago the returns on capital were 33%, but since then they've fallen to 17%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

Our Take On NewMarket's ROCE

To conclude, we've found that NewMarket is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 13% in the last five years. Therefore based on the analysis done in this article, we don't think NewMarket has the makings of a multi-bagger.

Like most companies, NewMarket does come with some risks, and we've found 1 warning sign that you should be aware of.

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.

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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.
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