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If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Ikwezi Mining (ASX:IKW) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for Ikwezi Mining:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = AU$1.2m ÷ (AU$28m - AU$6.9m) (Based on the trailing twelve months to December 2020).
So, Ikwezi Mining has an ROCE of 5.5%. On its own that's a low return, but compared to the average of 1.0% generated by the Oil and Gas industry, it's much better.
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're interested in investigating Ikwezi Mining's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is Ikwezi Mining's ROCE Trending?
The fact that Ikwezi Mining is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 5.5% on its capital. In addition to that, Ikwezi Mining is employing 57% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 24% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
What We Can Learn From Ikwezi Mining's ROCE
To the delight of most shareholders, Ikwezi Mining has now broken into profitability. Given the stock has declined 55% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.
If you want to know some of the risks facing Ikwezi Mining we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.
While Ikwezi Mining isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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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