Investors Will Want Largo's (TSE:LGO) Growth In ROCE To Persist

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Largo (TSE:LGO) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Largo:

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

0.12 = US$37m ÷ (US$359m - US$62m) (Based on the trailing twelve months to June 2022).

Thus, Largo has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 3.5% generated by the Metals and Mining industry.

Check out the opportunities and risks within the CA Metals and Mining industry.

In the above chart we have measured Largo's 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

We're delighted to see that Largo 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 12% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Largo is utilizing 60% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

One more thing to note, Largo has decreased current liabilities to 17% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

Our Take On Largo's ROCE

In summary, it's great to see that Largo has managed to break into profitability and is continuing to reinvest in its business. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

While Largo looks impressive, no company is worth an infinite price. The intrinsic value infographic in our free research report helps visualize whether LGO is currently trading for a fair price.

While Largo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.