Hindustan Oil Exploration (NSE:HINDOILEXP) Might Be Having Difficulty Using Its Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at Hindustan Oil Exploration (NSE:HINDOILEXP), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Hindustan Oil Exploration is:

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

0.13 = ₹1.9b ÷ (₹20b - ₹4.4b) (Based on the trailing twelve months to June 2024).

Thus, Hindustan Oil Exploration has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Oil and Gas industry average of 12%.

See our latest analysis for Hindustan Oil Exploration

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 , check out these free graphs detailing revenue and cash flow performance of Hindustan Oil Exploration.

What Can We Tell From Hindustan Oil Exploration's ROCE Trend?

On the surface, the trend of ROCE at Hindustan Oil Exploration doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 13%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Hindustan Oil Exploration's current liabilities have increased over the last five years to 22% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Hindustan Oil Exploration's ROCE

While returns have fallen for Hindustan Oil Exploration in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 102% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we've found 1 warning sign for Hindustan Oil Exploration that we think you should be aware of.

While Hindustan Oil Exploration isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.