Returns On Capital Are Showing Encouraging Signs At CHK Oil (HKG:632)

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 CHK Oil's (HKG:632) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

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 CHK Oil, this is the formula:

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

0.18 = HK$68m ÷ (HK$514m - HK$135m) (Based on the trailing twelve months to June 2021).

Thus, CHK Oil has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Oil and Gas industry average of 8.7% it's much better.

View 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're interested in investigating CHK Oil's past further, check out this free graph of past earnings, revenue and cash flow.

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

It's great to see that CHK Oil has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 18% which is no doubt a relief for some early shareholders. 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 20%. 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. Effectively this means that suppliers or short-term creditors are now funding 26% of the business, which is more than it was five years ago. 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 a nutshell, we're pleased to see that CHK Oil has been able to generate higher returns from less capital. Although the company may be facing some issues elsewhere since the stock has plunged 94% 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.

One more thing: We've identified 4 warning signs with CHK Oil (at least 1 which is a bit concerning) , and understanding these would certainly be useful.

While CHK Oil isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.