If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at CNOOC (HKG:883) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for CNOOC, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.085 = CN¥56b ÷ (CN¥750b - CN¥95b) (Based on the trailing twelve months to June 2020).
Therefore, CNOOC has an ROCE of 8.5%. In absolute terms, that's a low return, but it's much better than the Oil and Gas industry average of 6.8%.
Above you can see how the current ROCE for CNOOC compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for CNOOC.
The Trend Of ROCE
There hasn't been much to report for CNOOC's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So don't be surprised if CNOOC doesn't end up being a multi-bagger in a few years time. This probably explains why CNOOC is paying out 55% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.
The Key Takeaway
In summary, CNOOC isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Since the stock has gained an impressive 64% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a final note, we've found 2 warning signs for CNOOC that we think you should be aware of.
While CNOOC 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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