A Look Into Chennai Petroleum's (NSE:CHENNPETRO) Impressive Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of Chennai Petroleum (NSE:CHENNPETRO) looks attractive right now, so lets see what the trend of returns can tell us.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Chennai Petroleum:

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

0.28 = ₹27b ÷ (₹160b - ₹66b) (Based on the trailing twelve months to June 2023).

Thus, Chennai Petroleum has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 15%.

Check out our latest analysis for Chennai Petroleum

In the above chart we have measured Chennai Petroleum's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

We'd be pretty happy with returns on capital like Chennai Petroleum. The company has consistently earned 28% for the last five years, and the capital employed within the business has risen 79% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 41% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously. We'd like to see this trend continue though because as it stands today, thats still a pretty high level.

In Conclusion...

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

Chennai Petroleum does have some risks, we noticed 4 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.