Investors Shouldn't Overlook Tullow Oil's (LON:TLW) Impressive Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at the ROCE trend of Tullow Oil (LON:TLW) we really liked what we saw.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Tullow Oil:

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

0.38 = US$1.8b ÷ (US$6.3b - US$1.6b) (Based on the trailing twelve months to June 2021).

Thus, Tullow Oil has an ROCE of 38%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 3.6%.

See our latest analysis for Tullow Oil

In the above chart we have measured Tullow Oil'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 Tullow Oil here for free.

What Does the ROCE Trend For Tullow Oil Tell Us?

It's great to see that Tullow Oil has started to generate some pre-tax earnings from prior investments. While the business is profitable now, it used to be incurring losses on invested capital five years ago. In regards to capital employed, Tullow Oil is using 52% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. This could potentially mean that the company is selling some of its assets.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 26% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Key Takeaway

In summary, it's great to see that Tullow Oil has been able to turn things around and earn higher returns on lower amounts of capital. And since the stock has dived 78% over the last five years, there may be other factors affecting the company's prospects. Still, it's worth doing some further research to see if the trends will continue into the future.

One final note, you should learn about the 4 warning signs we've spotted with Tullow Oil (including 2 which are concerning) .

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.