What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we're seeing at Parex Resources' (TSE:PXT) look very promising so lets take 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 Parex Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.43 = US$781m ÷ (US$2.3b - US$509m) (Based on the trailing twelve months to December 2022).
So, Parex Resources has an ROCE of 43%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 20%.
See our latest analysis for Parex Resources
In the above chart we have measured Parex Resources' 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 Parex Resources here for free.
What The Trend Of ROCE Can Tell Us
Investors would be pleased with what's happening at Parex Resources. Over the last five years, returns on capital employed have risen substantially to 43%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 87%. So we're very much inspired by what we're seeing at Parex Resources thanks to its ability to profitably reinvest capital.
Our Take On Parex Resources' ROCE
To sum it up, Parex Resources has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 30% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
On a final note, we've found 1 warning sign for Parex Resources that we think you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.
About TSX:PXT
Parex Resources
Engages in the exploration, development, production, and marketing of oil and natural gas in Colombia.
Undervalued with excellent balance sheet and pays a dividend.
