MEG Energy (TSE:MEG) Shareholders Will Want The ROCE Trajectory To Continue

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 MEG Energy's (TSE:MEG) 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. To calculate this metric for MEG Energy, this is the formula:

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

0.19 = CA$1.2b ÷ (CA$6.9b - CA$645m) (Based on the trailing twelve months to March 2023).

Therefore, MEG Energy has an ROCE of 19%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Oil and Gas industry average of 20%.

View our latest analysis for MEG Energy

In the above chart we have measured MEG Energy'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.

So How Is MEG Energy's ROCE Trending?

MEG Energy has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 3,080%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 21% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

The Bottom Line

In the end, MEG Energy has proven it's capital allocation skills are good with those higher returns from less amount of capital. Since the stock has returned a staggering 119% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if MEG Energy can keep these trends up, it could have a bright future ahead.

One more thing to note, we've identified 1 warning sign with MEG Energy and understanding this should be part of your investment process.

While MEG 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.