If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, Lynas Rare Earths (ASX:LYC) 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 Lynas Rare Earths:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.012 = AU$15m ÷ (AU$1.3b - AU$77m) (Based on the trailing twelve months to December 2020).
Therefore, Lynas Rare Earths has an ROCE of 1.2%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 8.9%.
Above you can see how the current ROCE for Lynas Rare Earths compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Lynas Rare Earths here for free.
What Does the ROCE Trend For Lynas Rare Earths Tell Us?
We're delighted to see that Lynas Rare Earths is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 1.2% on its capital. Not only that, but the company is utilizing 84% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
The Key Takeaway
In summary, it's great to see that Lynas Rare Earths has managed to break into profitability and is continuing to reinvest in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On a final note, we've found 2 warning signs for Lynas Rare Earths that we think you should be aware of.
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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