There Are Reasons To Feel Uneasy About Lynas Rare Earths' (ASX:LYC) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Having said that, from a first glance at Lynas Rare Earths (ASX:LYC) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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)

0.023 = AU$62m ÷ (AU$2.8b - AU$169m) (Based on the trailing twelve months to June 2024).

Thus, Lynas Rare Earths has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 10%.

Check out 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 .

How Are Returns Trending?

When we looked at the ROCE trend at Lynas Rare Earths, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.3% from 6.9% five years ago. 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

We're a bit apprehensive about Lynas Rare Earths because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 191%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Lynas Rare Earths (of which 1 doesn't sit too well with us!) that you should know about.

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.

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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.