What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Mount Gibson Iron's (ASX:MGX) returns on capital, so let's have a look.
Understanding 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 Mount Gibson Iron:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.14 = AU$104m ÷ (AU$805m – AU$81m) (Based on the trailing twelve months to June 2020).
Thus, Mount Gibson Iron has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 9.4% it's much better.
Above you can see how the current ROCE for Mount Gibson Iron 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 Mount Gibson Iron here for free.
The Trend Of ROCE
We're delighted to see that Mount Gibson Iron is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 14% on its capital. And unsurprisingly, like most companies trying to break into the black, Mount Gibson Iron is utilizing 110% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
What We Can Learn From Mount Gibson Iron's ROCE
Long story short, we're delighted to see that Mount Gibson Iron's reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 487% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you'd like to know about the risks facing Mount Gibson Iron, we've discovered 3 warning signs that you should be aware of.
While Mount Gibson Iron may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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