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. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Mastercard (NYSE:MA), we aren’t jumping out of our chairs because returns are decreasing.
What is 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. The formula for this calculation on Mastercard is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.41 = US$9.0b ÷ (US$32b – US$9.9b) (Based on the trailing twelve months to June 2020).
Thus, Mastercard has an ROCE of 41%. In absolute terms that’s a great return and it’s even better than the IT industry average of 10%.
Check out our latest analysis for Mastercard
Above you can see how the current ROCE for Mastercard compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Mastercard’s ROCE Trend?
In terms of Mastercard’s historical ROCE movements, the trend isn’t fantastic. While it’s comforting that the ROCE is high, five years ago it was 59%. However it looks like Mastercard might be reinvesting for long term growth because while capital employed has increased, the company’s sales haven’t changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Mastercard has done well to pay down its current liabilities to 31% of total assets. That could partly explain why the ROCE has dropped. 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.
The Bottom Line
In summary, Mastercard is reinvesting funds back into the business for growth but unfortunately it looks like sales haven’t increased much just yet. Investors must think there’s better things to come because the stock has knocked it out of the park delivering a 276% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn’t get our hopes up too high.
If you want to continue researching Mastercard, you might be interested to know about the 1 warning sign that our analysis has discovered.
If you’d like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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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