We Like These Underlying Return On Capital Trends At Australis Oil & Gas (ASX:ATS)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Australis Oil & Gas (ASX:ATS) so let's look a bit deeper.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Australis Oil & Gas is:

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

0.0093 = US$700k ÷ (US$91m - US$16m) (Based on the trailing twelve months to June 2022).

Therefore, Australis Oil & Gas has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 12%.

See our latest analysis for Australis Oil & Gas

Historical performance is a great place to start when researching a stock so above you can see the gauge for Australis Oil & Gas' ROCE against it's prior returns. If you'd like to look at how Australis Oil & Gas has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We're delighted to see that Australis Oil & Gas 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 0.9% which is no doubt a relief for some early shareholders. In regards to capital employed, Australis Oil & Gas is using 38% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. Australis Oil & Gas could be selling under-performing assets since the ROCE is improving.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 17% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Key Takeaway

In summary, it's great to see that Australis Oil & Gas has been able to turn things around and earn higher returns on lower amounts of capital. And since the stock has dived 89% over the last five years, there may be other factors affecting the company's prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

One more thing to note, we've identified 2 warning signs with Australis Oil & Gas and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.