What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Arconic (NYSE:ARNC) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for Arconic, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.034 = US$167m ÷ (US$6.6b - US$1.6b) (Based on the trailing twelve months to March 2021).
Thus, Arconic has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 12%.
Above you can see how the current ROCE for Arconic 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 Arconic here for free.
What Does the ROCE Trend For Arconic Tell Us?
When we looked at the ROCE trend at Arconic, we didn't gain much confidence. Over the last three years, returns on capital have decreased to 3.4% from 7.5% three years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Key Takeaway
In summary, we're somewhat concerned by Arconic's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 121% over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Arconic (of which 1 is a bit unpleasant!) that you should know about.
While Arconic 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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