To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. With that in mind, we've noticed some promising trends at Lynas Rare Earths (ASX:LYC) so let's look a bit deeper.
What is Return On Capital Employed (ROCE)?
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 Lynas Rare Earths:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.11 = AU$156m ÷ (AU$1.5b – AU$108m) (Based on the trailing twelve months to June 2021).
Thus, Lynas Rare Earths has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 9.5% generated by the Metals and Mining industry.
Above you can see how the current ROCE for Lynas Rare Earths 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 Does the ROCE Trend For Lynas Rare Earths Tell Us?
Lynas Rare Earths has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 11% which is a sight for sore eyes. In addition to that, Lynas Rare Earths is employing 103% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
The Bottom Line
To the delight of most shareholders, Lynas Rare Earths has now broken into profitability. Since the stock has returned a staggering 1,087% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 1 warning sign with Lynas Rare Earths and understanding this should be part of your investment process.
While Lynas Rare Earths 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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