Red River Resources (ASX:RVR) Shareholders Will Want The ROCE Trajectory To Continue

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Speaking of which, we noticed some great changes in Red River Resources' (ASX:RVR) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Red River Resources, this is the formula:

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

0.14 = AU$11m ÷ (AU$102m - AU$24m) (Based on the trailing twelve months to December 2020).

Thus, Red River Resources has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 9.5% generated by the Metals and Mining industry.

View our latest analysis for Red River Resources

Above you can see how the current ROCE for Red River Resources compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

We're delighted to see that Red River Resources is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 14% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Red River Resources is utilizing 272% 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.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 23% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

In Conclusion...

Overall, Red River Resources gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a solid 73% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. 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.

Like most companies, Red River Resources does come with some risks, and we've found 1 warning sign that you should be aware of.

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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