Canacol Energy (TSE:CNE) Is Looking To Continue Growing Its 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Canacol Energy (TSE:CNE) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Canacol Energy is:

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

0.16 = US$123m ÷ (US$876m - US$126m) (Based on the trailing twelve months to September 2022).

Thus, Canacol Energy has an ROCE of 16%. In absolute terms, that's a pretty standard return but compared to the Oil and Gas industry average it falls behind.

View our latest analysis for Canacol Energy

Above you can see how the current ROCE for Canacol Energy 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 The Trend Of ROCE Can Tell Us

Canacol Energy is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 744% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

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. The current liabilities has increased to 14% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. 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.

Our Take On Canacol Energy's ROCE

As discussed above, Canacol Energy appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And since the stock has fallen 38% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.

One more thing: We've identified 2 warning signs with Canacol Energy (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

While Canacol Energy 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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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.