If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. And in light of that, the trends we're seeing at Arch Resources' (NYSE:ARCH) look very promising so lets take a look.
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 Arch Resources is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.42 = US$685m ÷ (US$2.2b - US$509m) (Based on the trailing twelve months to March 2022).
Thus, Arch Resources has an ROCE of 42%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 12%.
Check out our latest analysis for Arch Resources
In the above chart we have measured Arch Resources' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Arch Resources' ROCE Trending?
Arch Resources is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 1,595% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
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 24% 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.
In Conclusion...
As discussed above, Arch Resources appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 131% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.