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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Tree Island Steel (TSE:TSL) and its ROCE trend, we weren't exactly thrilled.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Tree Island Steel is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0087 = CA$1.3m ÷ (CA$170m - CA$20m) (Based on the trailing twelve months to September 2024).
Thus, Tree Island Steel has an ROCE of 0.9%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 2.7%.
Check out our latest analysis for Tree Island Steel
Historical performance is a great place to start when researching a stock so above you can see the gauge for Tree Island Steel's ROCE against it's prior returns. If you'd like to look at how Tree Island Steel has performed in the past in other metrics, you can view this free graph of Tree Island Steel's past earnings, revenue and cash flow.
So How Is Tree Island Steel's ROCE Trending?
On the surface, the trend of ROCE at Tree Island Steel doesn't inspire confidence. To be more specific, ROCE has fallen from 2.2% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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.
On a side note, Tree Island Steel has done well to pay down its current liabilities to 11% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Tree Island Steel's ROCE
We're a bit apprehensive about Tree Island Steel because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Since the stock has skyrocketed 153% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.