If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. Speaking of which, we noticed some great changes in Perpetual Energy's (TSE:PMT) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Perpetual Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.09 = CA$4.5m ÷ (CA$135m - CA$85m) (Based on the trailing twelve months to March 2021).
So, Perpetual Energy has an ROCE of 9.0%. In absolute terms, that's a low return, but it's much better than the Oil and Gas industry average of 1.9%.
Check out our latest analysis for Perpetual Energy
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Perpetual Energy has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Perpetual Energy's ROCE Trend?
It's great to see that Perpetual Energy has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 9.0% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 91% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. This could potentially mean that the company is selling some of its assets.
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. Effectively this means that suppliers or short-term creditors are now funding 63% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.
What We Can Learn From Perpetual Energy's ROCE
In a nutshell, we're pleased to see that Perpetual Energy has been able to generate higher returns from less capital. And since the stock has dived 82% over the last five years, there may be other factors affecting the company's prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Perpetual Energy (of which 2 shouldn't be ignored!) that you should know about.
While Perpetual Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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About TSX:PMT
Perpetual Energy
Engages in the exploration, production, and marketing of oil and natural gas in Canada.
Mediocre balance sheet and slightly overvalued.
