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

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. 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.

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. 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)

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

So, 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 10.0%.

See our latest analysis for Lynas Rare Earths

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 for free.

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

In terms of Lynas Rare Earths' historical ROCE movements, the trend isn't fantastic. 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.

The Bottom Line

In summary, we're somewhat concerned by Lynas Rare Earths' diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 184%. 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 2 warning signs we've spotted with Lynas Rare Earths (including 1 which makes us a bit uncomfortable) .

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.