We Think Imperial Oil (TSE:IMO) Might Have The DNA Of A Multi-Bagger

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. 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 Imperial Oil's (TSE:IMO) 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 Imperial Oil:

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

0.20 = CA$7.0b ÷ (CA$45b - CA$10b) (Based on the trailing twelve months to June 2022).

Therefore, Imperial Oil has an ROCE of 20%. In absolute terms that's a very respectable return and compared to the Oil and Gas industry average of 18% it's pretty much on par.

Check out our latest analysis for Imperial Oil

In the above chart we have measured Imperial Oil's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

Imperial Oil has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 946% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

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 22% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

In Conclusion...

To sum it up, Imperial Oil is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has returned a solid 99% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you want to continue researching Imperial Oil, you might be interested to know about the 1 warning sign that our analysis has discovered.

Imperial Oil is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.