Egdon Resources (LON:EDR) Is Experiencing Growth In Returns On Capital
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Speaking of which, we noticed some great changes in Egdon Resources' (LON:EDR) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What Is It?
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 Egdon Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = UK£2.6m ÷ (UK£38m - UK£2.6m) (Based on the trailing twelve months to July 2022).
Thus, Egdon Resources has an ROCE of 7.3%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 11%.
View our latest analysis for Egdon Resources
In the above chart we have measured Egdon Resources' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Egdon Resources.
The Trend Of ROCE
We're delighted to see that Egdon Resources is reaping rewards from its investments and has now 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 7.3%, 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. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.
The Bottom Line
As discussed above, Egdon Resources appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Astute investors may have an opportunity here because the stock has declined 60% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.
If you'd like to know more about Egdon Resources, we've spotted 4 warning signs, and 1 of them is concerning.
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.
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