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.
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 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.
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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.
Gulf Keystone Petroleum
Gulf Keystone Petroleum Limited engages in the exploration, evaluation, and production of oil and gas properties in the Kurdistan Region of Iraq and the United Kingdom.
Outstanding track record with flawless balance sheet and pays a dividend.