Can Essential Metals (ASX:ESS) Continue To Grow Its Returns On Capital?

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Essential Metals is:

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).

Thus, Essential Metals has an ROCE of 6.2%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 9.5%.

Check out our latest analysis for Essential Metals

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.

What Does the ROCE Trend For Essential Metals Tell Us?

Essential Metals 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 6.2% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Essential Metals is utilizing 100% more capital than it was five years ago. 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.

Our Take On Essential Metals' ROCE

Long story short, we're delighted to see that Essential Metals' reinvestment activities have paid off and the company is now profitable. And since the stock has fallen 43% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

One more thing, we've spotted 2 warning signs facing Essential Metals that you might find interesting.

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.

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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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