To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Woodside Petroleum (ASX:WPL) we aren't filled with optimism, but let's investigate further.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Woodside Petroleum is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0015 = US$35m ÷ (US$25b - US$2.1b) (Based on the trailing twelve months to December 2020).
Thus, Woodside Petroleum has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 1.3%.
Above you can see how the current ROCE for Woodside Petroleum 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 Woodside Petroleum here for free.
What Does the ROCE Trend For Woodside Petroleum Tell Us?
In terms of Woodside Petroleum's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 1.6%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Woodside Petroleum becoming one if things continue as they have.
In summary, it's unfortunate that Woodside Petroleum is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 9.4% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
Woodside Petroleum does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit concerning...
While Woodside Petroleum may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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Woodside Energy Group
Woodside Energy Group Ltd engages in the exploration, evaluation, development, production, marketing, and sale of hydrocarbons in Oceania, Asia, Canada, Africa, and internationally.
Excellent balance sheet with proven track record and pays a dividend.