Will the Promising Trends At Essential Metals (ASX:ESS) Continue?

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Essential Metals (ASX:ESS) looks quite promising in regards to its trends of return on capital.

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 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 December 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 11%.

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 Can We Tell From Essential Metals' ROCE Trend?

The fact that Essential Metals is now generating some pre-tax profits from its prior investments is very encouraging. 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. In addition to that, Essential Metals is employing 100% more capital than previously which is expected of a company that's trying to break into profitability. 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.

In Conclusion...

To the delight of most shareholders, Essential Metals has now broken into profitability. 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.

One more thing to note, we've identified 3 warning signs with Essential Metals and understanding these should be part of your investment process.

While Essential Metals isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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