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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. So when we looked at Golden Star Resources (TSE:GSC), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Golden Star Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.35 = US$93m ÷ (US$383m - US$115m) (Based on the trailing twelve months to June 2021).
So, Golden Star Resources has an ROCE of 35%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 2.7%.
Above you can see how the current ROCE for Golden Star Resources 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 Golden Star Resources here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Golden Star Resources, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 50% where it was five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Golden Star Resources has done well to pay down its current liabilities to 30% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Golden Star Resources is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 43% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
Like most companies, Golden Star Resources does come with some risks, and we've found 2 warning signs that you should be aware of.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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