Under The Bonnet, Tullow Oil's (LON:TLW) Returns Look Impressive

If you're looking for a multi-bagger, there's a few things to keep an eye out 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of Tullow Oil (LON:TLW) looks great, so lets see what the trend can tell us.

Understanding 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).

So, Tullow Oil has an ROCE of 38%. That's a fantastic return and not only that, it outpaces the average of 3.9% earned by companies in a similar industry.

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.

How Are Returns Trending?

Like most people, we're pleased that Tullow Oil is now generating some pretax earnings. While the business is profitable now, it used to be incurring losses on invested capital five years ago. Additionally, the business is utilizing 52% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 26% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line

From what we've seen above, Tullow Oil has managed to increase it's returns on capital all the while reducing it's capital base. Although the company may be facing some issues elsewhere since the stock has plunged 77% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.

Tullow Oil does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.