Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Speaking of which, we noticed some great changes in Image Resources' (ASX:IMA) returns on capital, so let's have a look.
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 Image Resources:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.33 = AU$44m ÷ (AU$172m - AU$39m) (Based on the trailing twelve months to December 2020).
Therefore, Image Resources has an ROCE of 33%. That's a fantastic return and not only that, it outpaces the average of 8.9% earned by companies in a similar industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Image Resources' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Image Resources, check out these free graphs here.
What Can We Tell From Image Resources' ROCE Trend?
The fact that Image Resources 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 33% on its capital. In addition to that, Image Resources is employing 10,266% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
The Key Takeaway
In summary, it's great to see that Image Resources has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 152% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Image Resources can keep these trends up, it could have a bright future ahead.
Like most companies, Image Resources does come with some risks, and we've found 1 warning sign that 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.
If you decide to trade Image Resources, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.