Did you know there are some financial metrics that can provide clues of a potential 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. And in light of that, the trends we're seeing at Iluka Resources' (ASX:ILU) look very promising so lets take a look.
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. Analysts use this formula to calculate it for Iluka Resources:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.30 = AU$452m ÷ (AU$1.9b - AU$362m) (Based on the trailing twelve months to December 2019).
Therefore, Iluka Resources has an ROCE of 30%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 9.8%.
In the above chart we have a measured Iluka Resources' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
Iluka Resources has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 1113%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 23% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 19% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
The Bottom Line
In the end, Iluka Resources has proven it's capital allocation skills are good with those higher returns from less amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 28% to shareholders. So with that in mind, we think the stock deserves further research.
On a final note, we've found 1 warning sign for Iluka Resources that we think you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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