To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Speaking of which, we noticed some great changes in Hartshead Resources' (ASX:HHR) returns on capital, so let's have a look.
What Is 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 Hartshead Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.036 = AU$1.3m ÷ (AU$38m - AU$2.8m) (Based on the trailing twelve months to June 2023).
Therefore, Hartshead Resources has an ROCE of 3.6%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 16%.
In the above chart we have measured Hartshead Resources' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Hartshead Resources.
How Are Returns Trending?
The fact that Hartshead Resources is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses three years ago, but now it's earning 3.6% which is a sight for sore eyes. In addition to that, Hartshead Resources is employing 28,712% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
On a related note, the company's ratio of current liabilities to total assets has decreased to 7.3%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line
Overall, Hartshead 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 since the stock has fallen 41% over the last year, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
If you want to know some of the risks facing Hartshead Resources we've found 4 warning signs (1 is a bit concerning!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.