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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Egdon Resources (LON:EDR) 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 Egdon Resources:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = UK£833k ÷ (UK£35m - UK£2.3m) (Based on the trailing twelve months to January 2022).
So, Egdon Resources has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 9.5%.
Above you can see how the current ROCE for Egdon 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 Does the ROCE Trend For Egdon Resources Tell Us?
Shareholders will be relieved that Egdon Resources has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 2.6%, which is always encouraging. 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. Because in the end, a business can only get so efficient.
The Bottom Line On Egdon Resources' ROCE
To sum it up, Egdon Resources is collecting higher returns from the same amount of capital, and that's impressive. And since the stock has fallen 33% 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.
Egdon Resources does have some risks, we noticed 4 warning signs (and 1 which can't be ignored) we think you should know about.
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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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.