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What are the early trends we should look for to identify a stock that could 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 on that note, Quanex Building Products (NYSE:NX) looks quite promising in regards to its trends of return on capital.
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. To calculate this metric for Quanex Building Products, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$56m ÷ (US$692m - US$130m) (Based on the trailing twelve months to October 2020).
So, Quanex Building Products has an ROCE of 10.0%. Ultimately, that's a low return and it under-performs the Building industry average of 15%.
In the above chart we have measured Quanex Building Products' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Quanex Building Products.
How Are Returns Trending?
Quanex Building Products has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 94% whilst employing roughly the same amount of capital. 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.
The Bottom Line On Quanex Building Products' ROCE
To sum it up, Quanex Building Products is collecting higher returns from the same amount of capital, and that's impressive. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 51% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Quanex Building Products does have some risks though, and we've spotted 2 warning signs for Quanex Building Products that you might be interested in.
While Quanex Building Products isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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