Energy Resources of Australia's (ASX:ERA) Returns On Capital Are Heading Higher

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Energy Resources of Australia (ASX:ERA) so let's look a bit deeper.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Energy Resources of Australia, this is the formula:

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

0.013 = AU$9.7m ÷ (AU$1.0b - AU$229m) (Based on the trailing twelve months to December 2020).

So, Energy Resources of Australia has an ROCE of 1.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 1.3%.

Check out our latest analysis for Energy Resources of Australia

Historical performance is a great place to start when researching a stock so above you can see the gauge for Energy Resources of Australia's ROCE against it's prior returns. If you'd like to look at how Energy Resources of Australia has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

It's great to see that Energy Resources of Australia has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 1.3% which is no doubt a relief for some early shareholders. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 20%. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 23% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. 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.

In Conclusion...

In the end, Energy Resources of Australia has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has fallen 11% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.

While Energy Resources of Australia 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.

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