Gulf Keystone Petroleum (LON:GKP) Knows How To Allocate Capital Effectively

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. And in light of that, the trends we're seeing at Gulf Keystone Petroleum's (LON:GKP) look very promising so lets take a look.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Gulf Keystone Petroleum, this is the formula:

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

0.44 = US$274m ÷ (US$744m - US$129m) (Based on the trailing twelve months to December 2022).

Therefore, Gulf Keystone Petroleum has an ROCE of 44%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 13%.

View our latest analysis for Gulf Keystone Petroleum

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.

The Trend Of ROCE

Gulf Keystone Petroleum has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 1,029% 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. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

Our Take On Gulf Keystone Petroleum's ROCE

As discussed above, Gulf Keystone Petroleum appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And since the stock has fallen 33% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Gulf Keystone Petroleum (of which 1 is a bit concerning!) that you should know about.

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.