Here's What's Concerning About Brookside Energy's (ASX:BRK) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. In light of that, when we looked at Brookside Energy (ASX:BRK) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. To calculate this metric for Brookside Energy, this is the formula:

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

0.081 = AU$4.8m ÷ (AU$81m - AU$21m) (Based on the trailing twelve months to June 2022).

So, Brookside Energy has an ROCE of 8.1%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 13%.

Check out our latest analysis for Brookside Energy

Historical performance is a great place to start when researching a stock so above you can see the gauge for Brookside Energy's ROCE against it's prior returns. If you're interested in investigating Brookside Energy's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Brookside Energy doesn't inspire confidence. Over the last five years, returns on capital have decreased to 8.1% from 20% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 26%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 8.1%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Brookside Energy's ROCE

While returns have fallen for Brookside Energy in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations.

Brookside Energy does have some risks, we noticed 4 warning signs (and 1 which can't be ignored) we think you should know about.

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.