Be Wary Of Grange Resources (ASX:GRR) And Its Returns On Capital
Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Grange Resources (ASX:GRR) and its ROCE trend, we weren't exactly thrilled.
What Is 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 Grange Resources:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = AU$144m ÷ (AU$1.1b - AU$60m) (Based on the trailing twelve months to June 2023).
So, Grange Resources has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 9.0% it's much better.
View our latest analysis for Grange Resources
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 Grange Resources 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 Grange Resources' ROCE Trend?
In terms of Grange Resources' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 25%, but since then they've fallen to 13%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
What We Can Learn From Grange Resources' ROCE
In summary, we're somewhat concerned by Grange Resources' diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 173% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you'd like to know about the risks facing Grange Resources, we've discovered 2 warning signs that you should be aware of.
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.
