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Fortescue Metals Group (ASX:FMG) Knows How To Allocate Capital Effectively

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·3 min read
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There are a few key trends to look for if we want to identify the next multi-bagger. 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. And in light of that, the trends we're seeing at Fortescue Metals Group's (ASX:FMG) look very promising so lets take a look.

What is 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. Analysts use this formula to calculate it for Fortescue Metals Group:

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

0.33 = US$6.9b ÷ (US$23b - US$2.8b) (Based on the trailing twelve months to June 2020).

Therefore, Fortescue Metals Group has an ROCE of 33%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 9.3%.

Check out our latest analysis for Fortescue Metals Group

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Above you can see how the current ROCE for Fortescue Metals Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Fortescue Metals Group.

What Can We Tell From Fortescue Metals Group's ROCE Trend?

Fortescue Metals Group is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 576% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

In Conclusion...

As discussed above, Fortescue Metals Group appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Fortescue Metals Group can keep these trends up, it could have a bright future ahead.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Fortescue Metals Group (of which 1 makes us a bit uncomfortable!) that you should know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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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