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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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 Renewable Energy Group (NASDAQ:REGI) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Renewable Energy Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = US$114m ÷ (US$1.8b - US$194m) (Based on the trailing twelve months to March 2021).
So, Renewable Energy Group has an ROCE of 7.1%. Even though it's in line with the industry average of 7.0%, it's still a low return by itself.
In the above chart we have measured Renewable Energy 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 Renewable Energy Group here for free.
What The Trend Of ROCE Can Tell Us
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. Over the last five years, returns on capital employed have risen substantially to 7.1%. The amount of capital employed has increased too, by 72%. So we're very much inspired by what we're seeing at Renewable Energy Group thanks to its ability to profitably reinvest capital.
One more thing to note, Renewable Energy Group has decreased current liabilities to 11% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Key Takeaway
To sum it up, Renewable Energy Group has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 698% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Renewable Energy Group (of which 1 is concerning!) that you should know about.
While Renewable Energy Group 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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