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

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at CHK Oil (HKG:632) so let's look a bit deeper.

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 CHK Oil:

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

0.005 = HK$2.6m ÷ (HK$553m - HK$38m) (Based on the trailing twelve months to December 2022).

Thus, CHK Oil has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 7.3%.

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'd like to look at how CHK Oil has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For CHK Oil Tell Us?

The fact that CHK Oil is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 0.5% on its capital. Not only that, but the company is utilizing 118% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 6.9%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Key Takeaway

Overall, CHK Oil gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And since the stock has dived 92% over the last five years, there may be other factors affecting the company's 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 1 warning sign with CHK Oil and understanding it 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. 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.