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Slowing Rates Of Return At Johnson Matthey (LON:JMAT) Leave Little Room For Excitement

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If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. So, when we ran our eye over Johnson Matthey's (LON:JMAT) trend of ROCE, we liked what we saw.

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)

0.12 = UK£510m ÷ (UK£7.7b - UK£3.6b) (Based on the trailing twelve months to March 2021).

Thus, Johnson Matthey has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 10% generated by the Chemicals industry.

View our latest analysis for Johnson Matthey

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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'd like to see what analysts are forecasting going forward, you should check out our free report for Johnson Matthey.

What Does the ROCE Trend For Johnson Matthey Tell Us?

While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 12% and the business has deployed 42% more capital into its operations. Since 12% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 46% of total assets, this reported ROCE would probably be less than12% because total capital employed would be higher.The 12% ROCE could be even lower if current liabilities weren't 46% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

What We Can Learn From Johnson Matthey's ROCE

To sum it up, Johnson Matthey has simply been reinvesting capital steadily, at those decent rates of return. In light of this, the stock has only gained 11% over the last five years for shareholders who have owned the stock in this period. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.

Johnson Matthey does have some risks though, and we've spotted 3 warning signs for Johnson Matthey that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.

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

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