Stock Analysis

Gulf Keystone Petroleum (LON:GKP) Is Doing The Right Things To Multiply Its Share Price

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LSE:GKP
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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at Gulf Keystone Petroleum (LON:GKP) so let's look a bit deeper.

What is 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. Analysts use this formula to calculate it for Gulf Keystone Petroleum:

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

0.11 = US$65m ÷ (US$715m - US$107m) (Based on the trailing twelve months to June 2021).

Thus, Gulf Keystone Petroleum has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Oil and Gas industry average of 3.9% it's much better.

View our latest analysis for Gulf Keystone Petroleum

roce
LSE:GKP Return on Capital Employed March 8th 2022

In the above chart we have measured Gulf Keystone Petroleum's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Gulf Keystone Petroleum.

What The Trend Of ROCE Can Tell Us

Shareholders will be relieved that Gulf Keystone Petroleum has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 11% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 15%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

In Conclusion...

In summary, we're delighted to see that Gulf Keystone Petroleum has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the stock has returned a staggering 143% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a final note, we found 2 warning signs for Gulf Keystone Petroleum (1 is significant) you should be aware of.

While Gulf Keystone Petroleum 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.

Valuation is complex, but we're helping make it simple.

Find out whether Gulf Keystone Petroleum is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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