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Investors Will Want Tungsten's (LON:TUNG) Growth In ROCE To Persist

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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Tungsten (LON:TUNG) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What is it?

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 Tungsten, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.0023 = UK£141k ÷ (UK£80m - UK£18m) (Based on the trailing twelve months to April 2021).

Thus, Tungsten has an ROCE of 0.2%. Ultimately, that's a low return and it under-performs the IT industry average of 13%.

View our latest analysis for Tungsten

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In the above chart we have measured Tungsten's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Tungsten.

What Can We Tell From Tungsten's ROCE Trend?

We're delighted to see that Tungsten is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but now it's turned around, earning 0.2% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 58% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 23% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. 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 Bottom Line

In summary, it's great to see that Tungsten has been able to turn things around and earn higher returns on lower amounts of capital. Astute investors may have an opportunity here because the stock has declined 55% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

If you'd like to know about the risks facing Tungsten, we've discovered 2 warning signs that you should be aware of.

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.

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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