Here's What's Concerning About South West Pinnacle Exploration's (NSE:SOUTHWEST) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at South West Pinnacle Exploration (NSE:SOUTHWEST) and its ROCE trend, we weren't exactly thrilled.

What is 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 South West Pinnacle Exploration, this is the formula:

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

0.15 = ₹163m ÷ (₹1.8b - ₹690m) (Based on the trailing twelve months to June 2021).

Thus, South West Pinnacle Exploration has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 14% generated by the Metals and Mining industry.

View our latest analysis for South West Pinnacle Exploration

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 South West Pinnacle Exploration, check out these free graphs here.

The Trend Of ROCE

In terms of South West Pinnacle Exploration's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 49% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, South West Pinnacle Exploration has decreased its current liabilities to 39% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

While returns have fallen for South West Pinnacle Exploration in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 179% to shareholders in the last three years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing, we've spotted 4 warning signs facing South West Pinnacle Exploration that you might find interesting.

While South West Pinnacle 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.

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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.
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