Returns On Capital Signal Tricky Times Ahead For African Rainbow Minerals (JSE:ARI)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating African Rainbow Minerals (JSE:ARI), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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. To calculate this metric for African Rainbow Minerals, this is the formula:

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

0.00047 = R31m ÷ (R71b - R5.5b) (Based on the trailing twelve months to June 2024).

So, African Rainbow Minerals has an ROCE of 0.05%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 13%.

Check out our latest analysis for African Rainbow Minerals

Above you can see how the current ROCE for African Rainbow Minerals compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering African Rainbow Minerals for free.

How Are Returns Trending?

In terms of African Rainbow Minerals' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 0.05% from 1.9% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for African Rainbow Minerals have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 132%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

African Rainbow Minerals does have some risks, we noticed 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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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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.