Shell (LON:SHEL) 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? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Shell's (LON:SHEL) returns on capital, so let's have a look.

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

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. To calculate this metric for Shell, this is the formula:

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

0.20 = US$64b ÷ (US$443b - US$121b) (Based on the trailing twelve months to December 2022).

Therefore, Shell has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 11%.

View our latest analysis for Shell

Above you can see how the current ROCE for Shell compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Shell here for free.

So How Is Shell's ROCE Trending?

Shell's ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 307% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

The Bottom Line

In summary, we're delighted to see that Shell has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 26% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

Shell does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Shell is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.