To make the best returns I can year after year, I want to invest in easy-to-understand UK shares with high-quality attributes. A shortcut to finding the latter is to focus on a metric known as return on capital employed (ROCE).
What is ROCE?
ROCE is a financial ratio, used by investors to measure a company’s profitability and the efficiency with which its capital is used. The higher the number the better, as it means management is investing money wisely to create more money. That can be the basis for either a growing dividend or — hopefully — growth, which will be reflected in an increasing share price, all being well.
It’s important because it helps show the quality of a company. If a business is buying assets that can’t generate returns, then the share price isn’t going to do well. If it can though, the opposite should be true. As an investor I want to see management investing for growth effectively and spending money to make more money in the future.
UK shares with high ROCE
Given the importance of ROCE, I set up a screen for companies with a reading above 20 and strong five-year cash flow growth. This simple screen offered up some UK shares I might consider adding to my portfolio.
They included iron ore pellet producer Ferrexpo (LSE: FXPO). Also on the list were UK shares such as Sylvania Platinum, Somero Enterprises, Boohoo, Team17 and a number of others. In total, the screen threw up 36 UK shares meeting the criteria.
Ferrexpo – a quality UK share?
Following this simple exercise, I wanted to take a more in-depth look at Ferrexpo. It should benefit this year from growth in economic activity, especially in emerging markets. Construction and other industries that use steel will push up demand for iron ore, which should in theory push up prices for Ferrexpo. A combination of volume and price increases could really help the top and bottom line.
Yet even though the future could be very bright, the P/E is only around four. That’s among the lowest P/E ratios I’ve seen. It makes me think the shares are very cheap, so the valuation is attractive. If I look at Evraz, which is bigger but broadly comparable, then its P/E is around eight.
As with any miner though, there are risks, because global markets (not the company) control prices for the product. Any fall, perhaps because a new variant of Covid slows down the global economic recovery, would very likely hit the Ferrexpo share price.
The company has in the past had governance issues too, which is off-putting for an investor like me. Its auditors investigated large payments to a charity suspected of being run by the chief executive. Also, its mines are in Ukraine, putting it at risk potentially from any Russian moves in that country.
As a miner there are always going to be a fair few risks. That said, the high return on capital employed, combined with a global economic recovery and the cheap valuation of the shares all make tempt to add Ferrexpo to my portfolio. It seems like a high-quality UK share to me.
