Here's What's Concerning About Lynas Rare Earths' (ASX:LYC) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Lynas Rare Earths (ASX:LYC) and its ROCE trend, we weren't exactly thrilled.

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Understanding 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. The formula for this calculation on Lynas Rare Earths is:

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

0.016 = AU$43m ÷ (AU$2.9b - AU$143m) (Based on the trailing twelve months to December 2024).

Therefore, Lynas Rare Earths has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 8.2%.

View our latest analysis for Lynas Rare Earths

In the above chart we have measured Lynas Rare Earths' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Lynas Rare Earths .

What Can We Tell From Lynas Rare Earths' ROCE Trend?

When we looked at the ROCE trend at Lynas Rare Earths, we didn't gain much confidence. Around five years ago the returns on capital were 3.9%, but since then they've fallen to 1.6%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

Our Take On Lynas Rare Earths' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Lynas Rare Earths 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 381% 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.

One final note, you should learn about the 3 warning signs we've spotted with Lynas Rare Earths (including 1 which can't be ignored) .

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. 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.