There Are Reasons To Feel Uneasy About Strategic Minerals' (LON:SML) Returns On Capital
If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. In light of that, when we looked at Strategic Minerals (LON:SML) and its ROCE trend, we weren't exactly thrilled.
What Is 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. The formula for this calculation on Strategic Minerals is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.011 = US$152k ÷ (US$14m - US$581k) (Based on the trailing twelve months to June 2022).
Therefore, Strategic Minerals has an ROCE of 1.1%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 11%.
Check out our latest analysis for Strategic Minerals
Historical performance is a great place to start when researching a stock so above you can see the gauge for Strategic Minerals' ROCE against it's prior returns. If you'd like to look at how Strategic Minerals has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
When we looked at the ROCE trend at Strategic Minerals, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.1% from 4.2% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a related note, Strategic Minerals has decreased its current liabilities to 4.1% of total assets. That could partly explain why the ROCE has dropped. 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.
What We Can Learn From Strategic Minerals' ROCE
In summary, we're somewhat concerned by Strategic Minerals' diminishing returns on increasing amounts of capital. This could explain why the stock has sunk a total of 84% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Strategic Minerals does have some risks, we noticed 5 warning signs (and 3 which can't be ignored) we think you should know about.
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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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