If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, CHK Oil (HKG:632) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on CHK Oil is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = HK$68m ÷ (HK$514m - HK$135m) (Based on the trailing twelve months to June 2021).
Thus, CHK Oil has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 8.6% generated by the Oil and Gas industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for CHK Oil's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of CHK Oil, check out these free graphs here.
So How Is CHK Oil's ROCE Trending?
It's great to see that CHK 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. 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%. CHK Oil could be selling under-performing assets since the ROCE is improving.
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. 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 Key Takeaway
From what we've seen above, CHK Oil has managed to increase it's returns on capital all the while reducing it's capital base. And since the stock has dived 95% 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.
If you'd like to know more about CHK Oil, we've spotted 3 warning signs, and 1 of them shouldn't be ignored.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.