Should You Be Impressed By Johnson Matthey's (LON:JMAT) Returns on Capital?
What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after investigating Johnson Matthey (LON:JMAT), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Johnson Matthey, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = UK£426m ÷ (UK£8.4b - UK£4.2b) (Based on the trailing twelve months to September 2020).
Thus, Johnson Matthey has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 10%.
See our latest analysis for Johnson Matthey
In the above chart we have measured Johnson Matthey'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.
The Trend Of ROCE
When we looked at the ROCE trend at Johnson Matthey, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 50%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 10%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
The Key Takeaway
While returns have fallen for Johnson Matthey in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 27% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
On a final note, we've found 4 warning signs for Johnson Matthey that we think 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.
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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