Hindustan Oil Exploration (NSE:HINDOILEXP) Is Looking To Continue Growing Its Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. So when we looked at Hindustan Oil Exploration (NSE:HINDOILEXP) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Hindustan Oil Exploration:

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

0.061 = ₹723m ÷ (₹15b - ₹3.5b) (Based on the trailing twelve months to June 2022).

Thus, Hindustan Oil Exploration has an ROCE of 6.1%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 14%.

Check out the opportunities and risks within the IN Oil and Gas industry.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hindustan Oil Exploration's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hindustan Oil Exploration, check out these free graphs here.

What Does the ROCE Trend For Hindustan Oil Exploration Tell Us?

Hindustan Oil Exploration has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 6.1% on its capital. In addition to that, Hindustan Oil Exploration is employing 158% more capital than previously which is expected of a company that's 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.

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. Essentially the business now has suppliers or short-term creditors funding about 23% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On Hindustan Oil Exploration's ROCE

In summary, it's great to see that Hindustan Oil Exploration has managed to break into profitability and is continuing to reinvest in its business. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 48% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you want to know some of the risks facing Hindustan Oil Exploration we've found 3 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

While Hindustan Oil Exploration 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.

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.