Be Wary Of Grange Resources (ASX:GRR) And 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. However, after briefly looking over the numbers, we don't think Grange Resources (ASX:GRR) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Grange Resources:

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

0.13 = AU$144m ÷ (AU$1.1b - AU$60m) (Based on the trailing twelve months to June 2023).

Therefore, Grange Resources has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 10% generated by the Metals and Mining industry.

Check out our latest analysis for Grange Resources

Historical performance is a great place to start when researching a stock so above you can see the gauge for Grange Resources' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Grange Resources, check out these free graphs here.

How Are Returns Trending?

On the surface, the trend of ROCE at Grange Resources doesn't inspire confidence. To be more specific, ROCE has fallen from 25% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

What We Can Learn From Grange Resources' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Grange Resources have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these poor fundamentals, the stock has gained a huge 234% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know about the risks facing Grange Resources, we've discovered 2 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.