Returns On Capital Are Showing Encouraging Signs At Lycopodium (ASX:LYL)

Simply Wall St
·3 min read

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Lycopodium (ASX:LYL) and its trend of ROCE, we really liked what we saw.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Lycopodium is:

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

0.12 = AU$12m ÷ (AU$155m - AU$60m) (Based on the trailing twelve months to December 2020).

Thus, Lycopodium has an ROCE of 12%. That's a pretty standard return and it's in line with the industry average of 12%.

See our latest analysis for Lycopodium

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Above you can see how the current ROCE for Lycopodium compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Lycopodium here for free.

What Can We Tell From Lycopodium's ROCE Trend?

Lycopodium has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 12% on its capital. Not only that, but the company is utilizing 51% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

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. Essentially the business now has suppliers or short-term creditors funding about 39% 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 Bottom Line On Lycopodium's ROCE

To the delight of most shareholders, Lycopodium has now broken into profitability. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Like most companies, Lycopodium does come with some risks, and we've found 2 warning signs that you should be aware of.

While Lycopodium may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

This article by Simply Wall St is general in nature. 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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