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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Lundin Gold (TSE:LUG) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
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 Lundin Gold, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$205m ÷ (US$1.5b - US$250m) (Based on the trailing twelve months to March 2021).
Therefore, Lundin Gold has an ROCE of 16%. On its own, that's a standard return, however it's much better than the -0.01% generated by the Metals and Mining industry.
In the above chart we have measured Lundin Gold's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Lundin Gold here for free.
So How Is Lundin Gold's ROCE Trending?
We're delighted to see that Lundin Gold is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 16% on its capital. And unsurprisingly, like most companies trying to break into the black, Lundin Gold is utilizing 405% more capital than it was five years ago. 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.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 17% of its operations, which isn't ideal. 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.
The Bottom Line On Lundin Gold's ROCE
To the delight of most shareholders, Lundin Gold has now broken into profitability. And a remarkable 104% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing, we've spotted 4 warning signs facing Lundin Gold that you might find interesting.
While Lundin Gold isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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