If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. However, after investigating Arch Resources (NYSE:ARCH), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Arch Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$308m ÷ (US$2.4b - US$327m) (Based on the trailing twelve months to June 2024).
Therefore, Arch Resources has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 9.9% it's much better.
Above you can see how the current ROCE for Arch Resources 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 Arch Resources for free.
The Trend Of ROCE
On the surface, the trend of ROCE at Arch Resources doesn't inspire confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 15%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
Our Take On Arch Resources' ROCE
In summary, we're somewhat concerned by Arch Resources' diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 144%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
On a final note, we've found 2 warning signs for Arch Resources that we think you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
