CHK Oil (HKG:632) Is Looking To Continue Growing Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in CHK Oil's (HKG:632) returns on capital, so let's have 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. The formula for this calculation on CHK Oil is:

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

0.05 = HK$17m ÷ (HK$543m - HK$194m) (Based on the trailing twelve months to December 2020).

Thus, CHK Oil has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 6.8%.

See our latest analysis for CHK Oil

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of CHK Oil, check out these free graphs here.

What Can We Tell From CHK Oil's ROCE Trend?

Like most people, we're pleased that CHK 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. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 27%. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

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. Essentially the business now has suppliers or short-term creditors funding about 36% of its operations, which isn't ideal. 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.

Our Take On CHK Oil's ROCE

In a nutshell, we're pleased to see that CHK Oil has been able to generate higher returns from less capital. However the stock is down a substantial 96% in the last five years so there could be other areas of the business hurting its prospects. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.

One more thing to note, we've identified 2 warning signs with CHK Oil and understanding them should be part of your investment process.

While CHK Oil 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. 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.
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