MEG Energy's (TSE:MEG) Returns On Capital Are Heading Higher

There are a few key trends to look for if we want to identify the next multi-bagger. 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. So when we looked at MEG Energy (TSE:MEG) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on MEG Energy is:

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

0.14 = CA$896m ÷ (CA$6.9b - CA$584m) (Based on the trailing twelve months to December 2023).

Therefore, MEG Energy has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 9.8% generated by the Oil and Gas industry.

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'd like, you can check out the forecasts from the analysts covering MEG Energy for free.

What Can We Tell From MEG Energy's ROCE Trend?

We're pretty happy with how the ROCE has been trending at MEG Energy. The data shows that returns on capital have increased by 1,016% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. 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.

Our Take On MEG Energy's ROCE

In the end, MEG Energy has proven it's capital allocation skills are good with those higher returns from less amount of capital. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.

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

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.