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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Largo (TSE:LGO) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What is it?
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 Largo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$32m ÷ (US$314m - US$42m) (Based on the trailing twelve months to December 2021).
Therefore, Largo has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 2.4% generated by the Metals and Mining industry.
In the above chart we have measured Largo's 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.
The Trend Of ROCE
The fact that Largo is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 12% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Largo is utilizing 41% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
One more thing to note, Largo has decreased current liabilities to 13% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line
Overall, Largo gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with a respectable 78% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On a separate note, we've found 2 warning signs for Largo you'll probably want to 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.