What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Lynas Rare Earths (ASX:LYC) and its trend of ROCE, we really liked what we saw.
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. To calculate this metric for Lynas Rare Earths, this is the formula:
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%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 9.3% it's much better.
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. About five years ago the company was generating losses but things have turned around because it's now earning 11% on its capital. And unsurprisingly, like most companies trying to break into the black, Lynas Rare Earths is utilizing 103% more capital than it was five years ago. 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 Bottom Line
Long story short, we're delighted to see that Lynas Rare Earths' reinvestment activities have paid off and the company is now profitable. And a remarkable 744% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
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.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
Lynas Rare Earths
Lynas Rare Earths Limited, together with its subsidiaries, engages in the exploration, development, mining, extraction, and processing of rare earth minerals primarily in Australia and Malaysia.
Flawless balance sheet with solid track record.