Lycopodium (ASX:LYL) Knows How To Allocate Capital Effectively
Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. And in light of that, the trends we're seeing at Lycopodium's (ASX:LYL) look very promising so lets take a look.
Understanding 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. Analysts use this formula to calculate it for Lycopodium:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.37 = AU$42m ÷ (AU$213m - AU$98m) (Based on the trailing twelve months to December 2022).
Therefore, Lycopodium has an ROCE of 37%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.
View our latest analysis for Lycopodium
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'd like to look at how Lycopodium has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Lycopodium's ROCE Trend?
We like the trends that we're seeing from Lycopodium. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 37%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 54%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
Another thing to note, Lycopodium has a high ratio of current liabilities to total assets of 46%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On Lycopodium's ROCE
In summary, it's great to see that Lycopodium can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing to note, we've identified 2 warning signs with Lycopodium and understanding these should be part of your investment process.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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