Investors Shouldn't Overlook Pipestone Energy's (TSE:PIPE) Impressive Returns On Capital

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. And in light of that, the trends we're seeing at Pipestone Energy's (TSE:PIPE) look very promising so lets take a look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Pipestone Energy, this is the formula:

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

0.36 = CA$307m ÷ (CA$1.1b - CA$208m) (Based on the trailing twelve months to September 2022).

Therefore, Pipestone Energy has an ROCE of 36%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 21%.

View our latest analysis for Pipestone Energy

Above you can see how the current ROCE for Pipestone 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 Can We Tell From Pipestone Energy's ROCE Trend?

We're delighted to see that Pipestone Energy is reaping rewards from its investments and is now generating some pre-tax profits. About four years ago the company was generating losses but things have turned around because it's now earning 36% on its capital. In addition to that, Pipestone Energy is employing 513% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 20% of the business, which is more than it was four years ago. 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 Pipestone Energy's ROCE

Overall, Pipestone Energy gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a solid 80% to shareholders over the last three years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Pipestone Energy can keep these trends up, it could have a bright future ahead.

If you'd like to know about the risks facing Pipestone Energy, we've discovered 2 warning signs that you should be aware of.

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.