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If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Sandfire Resources (ASX:SFR) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Sandfire Resources is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = AU$132m ÷ (AU$887m - AU$74m) (Based on the trailing twelve months to December 2019).
So, Sandfire Resources has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.8% generated by the Metals and Mining industry.
See our latest analysis for Sandfire Resources
In the above chart we have a measured Sandfire Resources' 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 Sandfire Resources here for free.
So How Is Sandfire Resources' ROCE Trending?
On the surface, the trend of ROCE at Sandfire Resources doesn't inspire confidence. To be more specific, ROCE has fallen from 32% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Sandfire Resources has done well to pay down its current liabilities to 8.3% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Sandfire Resources' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Sandfire Resources is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 8.2% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.