Returns At Red River Resources (ASX:RVR) Are On The Way Up

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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at Red River Resources (ASX:RVR) so let's look a bit deeper.

Understanding 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. Analysts use this formula to calculate it for Red River Resources:

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

0.14 = AU$11m ÷ (AU$114m - AU$36m) (Based on the trailing twelve months to June 2021).

Therefore, Red River Resources has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 9.4% it's much better.

Check out our latest analysis for Red River Resources

In the above chart we have measured Red River Resources' 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 The Trend Of ROCE Can Tell Us

Red River Resources has recently broken into profitability so their prior investments seem to be paying off. 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. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 32% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On Red River Resources' ROCE

Long story short, we're delighted to see that Red River Resources' reinvestment activities have paid off and the company is now profitable. And since the stock has fallen 14% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

On a separate note, we've found 1 warning sign for Red River Resources you'll probably want to know about.

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.

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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