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. With that in mind, the ROCE of Metcash (ASX:MTS) looks decent, right now, so lets see what the trend of returns can tell us.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Metcash, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = AU$428m ÷ (AU$5.2b - AU$2.7b) (Based on the trailing twelve months to April 2022).
Thus, Metcash has an ROCE of 17%. By itself that's a normal return on capital and it's in line with the industry's average returns of 17%.
In the above chart we have measured Metcash'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 Metcash here for free.
How Are Returns Trending?
The trend of ROCE doesn't stand out much, but returns on a whole are decent. Over the past five years, ROCE has remained relatively flat at around 17% and the business has deployed 26% more capital into its operations. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
On a side note, Metcash's current liabilities are still rather high at 52% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Metcash's ROCE
To sum it up, Metcash has simply been reinvesting capital steadily, at those decent rates of return. And the stock has followed suit returning a meaningful 99% to shareholders over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Like most companies, Metcash does come with some risks, and we've found 1 warning sign that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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