Lynas Rare Earths' (ASX:LYC) Returns On Capital Are Heading Higher

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Lynas Rare Earths (ASX:LYC) and its trend of ROCE, we really liked what we saw.

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

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

0.11 = AU$156m ÷ (AU$1.5b - AU$108m) (Based on the trailing twelve months to June 2021).

Thus, Lynas Rare Earths has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 9.4% generated by the Metals and Mining industry.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Lynas Rare Earths Tell Us?

The fact that Lynas Rare Earths 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 11% on its capital. Not only that, but the company is utilizing 103% 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

Long story short, we're delighted to see that Lynas Rare Earths' reinvestment activities have paid off and the company is now profitable. 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.

Lynas Rare Earths does have some risks though, and we've spotted 1 warning sign for Lynas Rare Earths that you might be interested in.

While Lynas Rare Earths may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.

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