Investors Could Be Concerned With South West Pinnacle Exploration's (NSE:SOUTHWEST) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating South West Pinnacle Exploration (NSE:SOUTHWEST), we don't think it's current trends fit the mold of a multi-bagger.

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. 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)

0.12 = ₹136m ÷ (₹1.8b - ₹678m) (Based on the trailing twelve months to December 2021).

Therefore, South West Pinnacle Exploration has an ROCE of 12%. In absolute terms, that's a pretty standard return but compared to the Metals and Mining industry average it falls behind.

See our latest analysis for South West Pinnacle Exploration

Historical performance is a great place to start when researching a stock so above you can see the gauge for South West Pinnacle Exploration's ROCE against it's prior returns. 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

On the surface, the trend of ROCE at South West Pinnacle Exploration doesn't inspire confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 12%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, South West Pinnacle Exploration has decreased its current liabilities to 38% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that South West Pinnacle Exploration is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 1,135% return over the last three years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

South West Pinnacle Exploration does have some risks, we noticed 3 warning signs (and 1 which is a bit concerning) we think you should 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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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.