Will Newton Resources' (HKG:1231) Growth In ROCE Persist?

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 Newton Resources (HKG:1231) so let's look a bit deeper.

What is 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 Newton Resources, this is the formula:

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

0.048 = CN¥13m ÷ (CN¥542m - CN¥270m) (Based on the trailing twelve months to June 2020).

Therefore, Newton Resources has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 7.5%.

See our latest analysis for Newton Resources

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Newton Resources, check out these free graphs here.

What Can We Tell From Newton Resources' ROCE Trend?

Like most people, we're pleased that Newton Resources is now generating some pretax earnings. While the business is profitable now, it used to be incurring losses on invested capital five years ago. In regards to capital employed, Newton Resources is using 73% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. Newton Resources could be selling under-performing assets since the ROCE is improving.

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. Effectively this means that suppliers or short-term creditors are now funding 50% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

Our Take On Newton Resources' ROCE

In a nutshell, we're pleased to see that Newton Resources has been able to generate higher returns from less capital. 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.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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