Mader Group (ASX:MAD) Could Be Struggling To Allocate Capital
What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Looking at Mader Group (ASX:MAD), it does have a high ROCE right now, but lets see how returns are trending.
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 Mader Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = AU$55m ÷ (AU$253m - AU$74m) (Based on the trailing twelve months to June 2023).
Therefore, Mader Group has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Commercial Services industry average of 9.4%.
View our latest analysis for Mader Group
In the above chart we have measured Mader 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 Mader Group here for free.
What Can We Tell From Mader Group's ROCE Trend?
On the surface, the trend of ROCE at Mader Group doesn't inspire confidence. Historically returns on capital were even higher at 39%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Mader Group has done well to pay down its current liabilities to 29% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From Mader Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Mader Group is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 640% return over the last three years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.
Like most companies, Mader Group does come with some risks, and we've found 1 warning sign that you should be aware of.
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.
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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.
