To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. And in light of that, the trends we're seeing at Ferrexpo's (LON:FXPO) look very promising so lets take 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. The formula for this calculation on Ferrexpo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.41 = US$684m ÷ (US$2.0b – US$296m) (Based on the trailing twelve months to December 2020).
So, Ferrexpo has an ROCE of 41%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 14%.
In the above chart we have measured Ferrexpo's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Ferrexpo's ROCE Trend?
The trends we've noticed at Ferrexpo are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 41%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 73%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line
In summary, it's great to see that Ferrexpo can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 2,120% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Ferrexpo does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is a bit unpleasant…
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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