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What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. So on that note, Archon Minerals (CVE:ACS) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Archon Minerals is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.00063 = CA$35k ÷ (CA$65m - CA$11m) (Based on the trailing twelve months to November 2020).
Therefore, Archon Minerals has an ROCE of 0.06%. Even though it's in line with the industry average of 0.4%, it's still a low return by itself.
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 Archon Minerals has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Archon Minerals Tell Us?
It's great to see that Archon Minerals has started to generate some pre-tax earnings from prior investments. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 0.06% on their capital employed. Additionally, the business is utilizing 26% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. Archon Minerals could be selling under-performing assets since the ROCE is improving.
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. Effectively this means that suppliers or short-term creditors are now funding 16% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
The Bottom Line On Archon Minerals' ROCE
From what we've seen above, Archon Minerals has managed to increase it's returns on capital all the while reducing it's capital base. And since the stock has dived 85% over the last five years, there may be other factors affecting the company's prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
If you want to know some of the risks facing Archon Minerals we've found 4 warning signs (3 shouldn't be ignored!) that you should be aware of before investing here.
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.
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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