Fortescue Metals Group (ASX:FMG) Is Very Good At Capital Allocation

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. So when we looked at the ROCE trend of Fortescue Metals Group (ASX:FMG) we really liked what we saw.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.44 = US$9.5b ÷ (US$24b – US$2.9b) (Based on the trailing twelve months to December 2020).

Therefore, Fortescue Metals Group has an ROCE of 44%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 8.9%.

See our latest analysis for Fortescue Metals Group

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In the above chart we have measured Fortescue Metals 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 Fortescue Metals Group here for free.

The Trend Of ROCE

Fortescue Metals Group is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 839% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

The Bottom Line

As discussed above, Fortescue Metals Group appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And a remarkable 950% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

If you want to know some of the risks facing Fortescue Metals Group we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

By Matt Earle

Matthew Earle is the Founder of MiningFeeds. In 2005, Matt founded MiningNerds.com to provide data and information to the mining investment community. This site was merged with Highgrade Review to form MiningFeeds. Matt has a B.Sc. degree with a minor in geology from the University of Toronto.

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