Returns Are Gaining Momentum At Source Energy Services (TSE:SHLE)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. So when we looked at Source Energy Services (TSE:SHLE) and its trend of ROCE, we really liked what we saw.

What Is 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. Analysts use this formula to calculate it for Source Energy Services:

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

0.047 = CA$11m ÷ (CA$327m - CA$87m) (Based on the trailing twelve months to December 2022).

Therefore, Source Energy Services has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 11%.

Check out our latest analysis for Source Energy Services

Above you can see how the current ROCE for Source Energy Services compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Source Energy Services.

So How Is Source Energy Services' ROCE Trending?

It's nice to see that ROCE is headed in the right direction, even if it is still relatively low. We found that the returns on capital employed over the last five years have risen by 259%. 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 39% 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.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 27% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

In Conclusion...

In the end, Source Energy Services has proven it's capital allocation skills are good with those higher returns from less amount of capital. Although the company may be facing some issues elsewhere since the stock has plunged 95% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.

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

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.