If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Hindustan Petroleum's (NSE:HINDPETRO) returns on capital, so let's have a look.
What is 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. The formula for this calculation on Hindustan Petroleum is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = ₹83b ÷ (₹1.2t - ₹565b) (Based on the trailing twelve months to December 2020).
Therefore, Hindustan Petroleum has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 5.0% generated by the Oil and Gas industry.
Above you can see how the current ROCE for Hindustan Petroleum compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Hindustan Petroleum's ROCE Trending?
The trends we've noticed at Hindustan Petroleum are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 13%. The amount of capital employed has increased too, by 33%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
Another thing to note, Hindustan Petroleum has a high ratio of current liabilities to total assets of 47%. 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
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Hindustan Petroleum has. Since the stock has returned a solid 76% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Hindustan Petroleum can keep these trends up, it could have a bright future ahead.
On a separate note, we've found 2 warning signs for Hindustan Petroleum you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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