Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at CNOOC (HKG:883) and its ROCE trend, we weren’t exactly thrilled.
What is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for CNOOC:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.12 = CN¥81b ÷ (CN¥758b – CN¥91b) (Based on the trailing twelve months to December 2019).
Therefore, CNOOC has an ROCE of 12%. In absolute terms, that’s a satisfactory return, but compared to the Oil and Gas industry average of 6.2% it’s much better.
Check out our latest analysis for CNOOC
In the above chart we have a measured CNOOC’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 CNOOC.
What Does the ROCE Trend For CNOOC Tell Us?
Things have been pretty stable at CNOOC, with its capital employed and returns on that capital staying somewhat the same for the last five years. It’s not uncommon to see this when looking at a mature and stable business that isn’t re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at CNOOC in terms of ROCE and additional investments being made, we wouldn’t hold our breath on it being a multi-bagger. This probably explains why CNOOC is paying out 48% of its income to shareholders in the form of dividends. Given the business isn’t reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
What We Can Learn From CNOOC’s ROCE
In summary, CNOOC isn’t compounding its earnings but is generating stable returns on the same amount of capital employed. And with the stock having returned a mere 21% in the last five years to shareholders, you could argue that they’re aware of these lackluster trends. So if you’re looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
Since virtually every company faces some risks, it’s worth knowing what they are, and we’ve spotted 2 warning signs for CNOOC (of which 1 is a bit concerning!) that 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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