If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. With that in mind, we've noticed some promising trends at Largo Resources (TSE:LGO) so let's look a bit deeper.
Return On Capital Employed (ROCE): What is it?
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 Largo Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = US$11m ÷ (US$261m - US$13m) (Based on the trailing twelve months to March 2021).
Thus, Largo Resources has an ROCE of 4.6%. On its own that's a low return, but compared to the average of 1.2% generated by the Metals and Mining industry, it's much better.
In the above chart we have measured Largo 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.
So How Is Largo Resources' ROCE Trending?
Shareholders will be relieved that Largo Resources has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 4.6% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
One more thing to note, Largo Resources has decreased current liabilities to 5.0% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Bottom Line On Largo Resources' ROCE
To sum it up, Largo Resources is collecting higher returns from the same amount of capital, and that's impressive. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Largo Resources does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.
While Largo Resources 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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