Why The 50% Return On Capital At West African Resources (ASX:WAF) Should Have Your Attention

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. And in light of that, the trends we're seeing at West African Resources' (ASX:WAF) look very promising so lets take a look.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for West African Resources, this is the formula:

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

0.50 = AU$153m ÷ (AU$531m - AU$223m) (Based on the trailing twelve months to December 2020).

So, West African Resources has an ROCE of 50%. That's a fantastic return and not only that, it outpaces the average of 8.9% earned by companies in a similar industry.

View our latest analysis for West African Resources

Above you can see how the current ROCE for West African Resources 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 West African Resources here for free.

What The Trend Of ROCE Can Tell Us

We're delighted to see that West African Resources is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making four years ago but is is now generating 50% on its capital. Not only that, but the company is utilizing 1,705% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 42% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.

What We Can Learn From West African Resources' ROCE

Long story short, we're delighted to see that West African Resources' reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 333% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

If you want to know some of the risks facing West African Resources we've found 2 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

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This article by Simply Wall St is general in nature. 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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