Returns on Capital Paint A Bright Future For Chennai Petroleum (NSE:CHENNPETRO)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. And in light of that, the trends we're seeing at Chennai Petroleum's (NSE:CHENNPETRO) look very promising so lets take a look.

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. To calculate this metric for Chennai Petroleum, this is the formula:

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

0.34 = ₹16b ÷ (₹142b - ₹94b) (Based on the trailing twelve months to March 2021).

Therefore, Chennai Petroleum has an ROCE of 34%. That's a fantastic return and not only that, it outpaces the average of 5.5% earned by companies in a similar industry.

View our latest analysis for Chennai Petroleum

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 want to delve into the historical earnings, revenue and cash flow of Chennai Petroleum, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

Chennai Petroleum has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 23% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

On a side note, Chennai Petroleum's current liabilities are still rather high at 66% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Chennai Petroleum's ROCE

In summary, we're delighted to see that Chennai Petroleum has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Astute investors may have an opportunity here because the stock has declined 22% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

Chennai Petroleum does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

Chennai Petroleum is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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