If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Image Resources (ASX:IMA) looks great, so lets see what the trend can tell us.
Return On Capital Employed (ROCE): What Is It?
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. To calculate this metric for Image Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.32 = AU$48m ÷ (AU$182m - AU$33m) (Based on the trailing twelve months to June 2022).
Therefore, Image Resources has an ROCE of 32%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 10%.
View our latest analysis for Image 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 Image Resources has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
So How Is Image Resources' ROCE Trending?
We're delighted to see that Image Resources is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 32% which is a sight for sore eyes. In addition to that, Image Resources is employing 813% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
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. The current liabilities has increased to 18% 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.
Our Take On Image Resources' ROCE
Overall, Image 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. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 37% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
Image Resources does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant...
Image Resources is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.
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