Returns On Capital Are Showing Encouraging Signs At Byron Energy (ASX:BYE)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Byron Energy's (ASX:BYE) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Byron Energy:

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

0.034 = US$3.4m ÷ (US$118m - US$20m) (Based on the trailing twelve months to December 2020).

Therefore, Byron Energy has an ROCE of 3.4%. On its own that's a low return, but compared to the average of 1.3% generated by the Oil and Gas industry, it's much better.

See our latest analysis for Byron Energy

Historical performance is a great place to start when researching a stock so above you can see the gauge for Byron Energy's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Byron Energy, check out these free graphs here.

The Trend Of ROCE

The fact that Byron Energy is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 3.4% on its capital. Not only that, but the company is utilizing 223% 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. 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

Overall, Byron Energy gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Astute investors may have an opportunity here because the stock has declined 26% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Byron Energy (of which 1 is significant!) 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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