What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. With that in mind, we’ve noticed some promising trends at Essential Metals (ASX:ESS) so let’s look a bit deeper.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you’re unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Essential Metals:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.062 = AU$1.1m ÷ (AU$20m – AU$1.5m) (Based on the trailing twelve months to June 2020).
Therefore, Essential Metals has an ROCE of 6.2%. In absolute terms, that’s a low return and it also under-performs the Metals and Mining industry average of 9.3%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you’re interested in investigating Essential Metals’ past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
Essential Metals has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 6.2% on its capital. And unsurprisingly, like most companies trying to break into the black, Essential Metals is utilizing 100% more capital than it was five years ago. This can indicate that there’s plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
The Key Takeaway
Long story short, we’re delighted to see that Essential Metals’ reinvestment activities have paid off and the company is now profitable. Given the stock has declined 51% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company’s current valuation metrics and future prospects seems fitting.
On a separate note, we’ve found 3 warning signs for Essential Metals you’ll probably want to know about.
While Essential Metals may not currently earn the highest returns, we’ve compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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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