There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Pilbara Minerals (ASX:PLS) and its trend of ROCE, we really liked what we saw.
Understanding 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 Pilbara Minerals, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = AU$139m ÷ (AU$1.2b - AU$154m) (Based on the trailing twelve months to December 2021).
So, Pilbara Minerals has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 8.8% generated by the Metals and Mining industry.
In the above chart we have measured Pilbara Minerals' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Pilbara Minerals here for free.
What The Trend Of ROCE Can Tell Us
We're delighted to see that Pilbara Minerals is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 13% on its capital. And unsurprisingly, like most companies trying to break into the black, Pilbara Minerals is utilizing 635% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
Long story short, we're delighted to see that Pilbara Minerals' reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 635% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing to note, we've identified 2 warning signs with Pilbara Minerals and understanding them should be part of your investment process.
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.
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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