What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Speaking of which, we noticed some great changes in Fortescue Metals Group's (ASX:FMG) returns on capital, so let's have 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)
0.35 = US$9.1b ÷ (US$28b - US$2.4b) (Based on the trailing twelve months to June 2022).
So, Fortescue Metals Group has an ROCE of 35%. That's a fantastic return and not only that, it outpaces the average of 8.7% earned by companies in a similar industry.
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, you can check out the forecasts from the analysts covering Fortescue Metals Group here for free.
What Does the ROCE Trend For Fortescue Metals Group Tell Us?
Fortescue Metals Group is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 35%. The amount of capital employed has increased too, by 53%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line
All in all, it's terrific to see that Fortescue Metals Group is reaping the rewards from prior investments and is growing its capital base. 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 2 warning signs for Fortescue Metals Group (of which 1 is a bit unpleasant!) 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.
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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.
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