What Do The Returns On Capital At South West Pinnacle Exploration (NSE:SOUTHWEST) Tell Us?

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating South West Pinnacle Exploration (NSE:SOUTHWEST), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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. 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)

0.11 = ₹117m ÷ (₹1.7b - ₹636m) (Based on the trailing twelve months to September 2020).

Thus, South West Pinnacle Exploration has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 9.6% generated by the Metals and Mining industry.

See 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're interested in investigating South West Pinnacle Exploration's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From South West Pinnacle Exploration's ROCE Trend?

On the surface, the trend of ROCE at South West Pinnacle Exploration doesn't inspire confidence. Over the last five years, returns on capital have decreased to 11% from 44% five years ago. However it looks like South West Pinnacle Exploration might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

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. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by South West Pinnacle Exploration's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 136% return in the last year, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

South West Pinnacle Exploration does have some risks, we noticed 5 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

While South West Pinnacle 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.

If you’re looking to trade South West Pinnacle Exploration, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.