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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Headwater Exploration (TSE:HWX) looks great, so lets see what the trend can tell us.
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. To calculate this metric for Headwater Exploration, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = CA$236m ÷ (CA$939m - CA$138m) (Based on the trailing twelve months to September 2024).
Thus, Headwater Exploration has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 9.4%.
Check out our latest analysis for Headwater Exploration
In the above chart we have measured Headwater Exploration'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 Headwater Exploration for free.
The Trend Of ROCE
Investors would be pleased with what's happening at Headwater Exploration. Over the last five years, returns on capital employed have risen substantially to 29%. The amount of capital employed has increased too, by 537%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
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 15% of its operations, which isn't ideal. 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 Key Takeaway
To sum it up, Headwater Exploration has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 787% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.