If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Although, when we looked at Master Drilling Group (JSE:MDI), it didn't seem to tick all of these boxes.
Understanding 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. To calculate this metric for Master Drilling Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.086 = US$18m ÷ (US$249m - US$39m) (Based on the trailing twelve months to June 2020).
Therefore, Master Drilling Group has an ROCE of 8.6%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 18%.
In the above chart we have measured Master Drilling Group'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 Master Drilling Group here for free.
How Are Returns Trending?
On the surface, the trend of ROCE at Master Drilling Group doesn't inspire confidence. To be more specific, ROCE has fallen from 20% over the last five years. However it looks like Master Drilling Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Our Take On Master Drilling Group's ROCE
In summary, Master Drilling Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 42% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
If you want to know some of the risks facing Master Drilling Group we've found 3 warning signs (1 shouldn't be ignored!) 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.
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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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