What trends should we look for it we want to identify stocks that can 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 Energy One (ASX:EOL) so let's look a bit deeper.
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 Energy One:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = AU$4.6m ÷ (AU$35m - AU$10m) (Based on the trailing twelve months to December 2020).
So, Energy One has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 14% it's much better.
In the above chart we have measured Energy One'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 Energy One.
What Does the ROCE Trend For Energy One Tell Us?
Investors would be pleased with what's happening at Energy One. The data shows that returns on capital have increased substantially over the last five years to 18%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 323%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line On Energy One's ROCE
All in all, it's terrific to see that Energy One is reaping the rewards from prior investments and is growing its capital base. And a remarkable 2,225% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you'd like to know about the risks facing Energy One, we've discovered 2 warning signs that you should be aware of.
While Energy One isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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