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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Bay Area Gold Group's (HKG:1194) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Bay Area Gold Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.012 = HK$60m ÷ (HK$10b - HK$5.4b) (Based on the trailing twelve months to June 2021).
Thus, Bay Area Gold Group has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Bay Area Gold Group's ROCE against it's prior returns. If you'd like to look at how Bay Area Gold Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The figures show that over the last five years, returns on capital have grown by 70%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 50% less than it was five years ago, which can be indicative of a business that's improving its efficiency. Bay Area Gold Group may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.
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 53% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
In a nutshell, we're pleased to see that Bay Area Gold Group has been able to generate higher returns from less capital. Although the company may be facing some issues elsewhere since the stock has plunged 99% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.
Bay Area Gold Group does have some risks, we noticed 3 warning signs (and 1 which is potentially serious) we think you should know about.
While Bay Area Gold Group 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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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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