If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Red River Resources (ASX:RVR) and its trend of ROCE, we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Red River Resources is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

0.14 = AU$11m ÷ (AU$102m – AU$24m) (Based on the trailing twelve months to December 2020).

Thus, Red River Resources has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 8.9% generated by the Metals and Mining industry.

See our latest analysis for Red River Resources

In the above chart we have measured Red River Resources' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Red River Resources here for free.

What The Trend Of ROCE Can Tell Us

We're delighted to see that Red River Resources is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 14% which is a sight for sore eyes. In addition to that, Red River Resources is employing 272% 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.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 23% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Key Takeaway

Overall, Red River Resources gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a solid 55% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

If you want to continue researching Red River Resources, you might be interested to know about the 1 warning sign that our analysis has discovered.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.

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