What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. So when we looked at Franco-Nevada (TSE:FNV) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Franco-Nevada:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.094 = US$485m ÷ (US$5.2b - US$38m) (Based on the trailing twelve months to June 2020).
So, Franco-Nevada has an ROCE of 9.4%. In absolute terms, that's a low return, but it's much better than the Metals and Mining industry average of 2.9%.
In the above chart we have a measured Franco-Nevada'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 Franco-Nevada here for free.
The Trend Of ROCE
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 9.4%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 53%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
The Bottom Line On Franco-Nevada's ROCE
To sum it up, Franco-Nevada has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these trends are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing to note, we've identified 2 warning signs with Franco-Nevada and understanding these should be part of your investment process.
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.
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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