West African Resources (ASX:WAF) Is Investing Its Capital With Increasing Efficiency
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. And in light of that, the trends we're seeing at West African Resources' (ASX:WAF) look very promising so lets take a look.
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 West African Resources:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.50 = AU$153m ÷ (AU$531m - AU$223m) (Based on the trailing twelve months to December 2020).
So, West African Resources has an ROCE of 50%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 9.5%.
View our latest analysis for West African Resources
In the above chart we have measured West African Resources' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
We're delighted to see that West African Resources is reaping rewards from its investments and is now generating some pre-tax profits. About four years ago the company was generating losses but things have turned around because it's now earning 50% on its capital. Not only that, but the company is utilizing 1,705% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 42% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Key Takeaway
Overall, West African Resources gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.
West African Resources does have some risks, we noticed 2 warning signs (and 1 which is concerning) we think you should know about.
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.
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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