Under The Bonnet, Petroreconcavo's (BVMF:RECV3) Returns Look Impressive

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at the ROCE trend of Petroreconcavo (BVMF:RECV3) we really liked what we saw.

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. Analysts use this formula to calculate it for Petroreconcavo:

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

0.20 = R$1.0b ÷ (R$6.5b - R$1.3b) (Based on the trailing twelve months to September 2022).

So, Petroreconcavo has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 8.2%.

View our latest analysis for Petroreconcavo

Above you can see how the current ROCE for Petroreconcavo compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Petroreconcavo's ROCE Trend?

The trends we've noticed at Petroreconcavo are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 20%. 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 1,149%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 20% of its operations, which isn't ideal. 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 Bottom Line On Petroreconcavo's ROCE

To sum it up, Petroreconcavo has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 54% return over the last year. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Petroreconcavo does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit concerning...

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.