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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at BP (LON:BP.) and its trend of ROCE, we really liked what we saw.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on BP is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$26b ÷ (US$280b - US$86b) (Based on the trailing twelve months to December 2023).
So, BP has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Oil and Gas industry average of 10% it's much better.
See our latest analysis for BP
In the above chart we have measured BP'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 BP for free.
What The Trend Of ROCE Can Tell Us
BP is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 84% whilst employing roughly the same amount of capital. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
Our Take On BP's ROCE
As discussed above, BP appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Considering the stock has delivered 20% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
One more thing: We've identified 2 warning signs with BP (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.
While BP may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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 LSE:BP.
Adequate balance sheet and fair value.
