Here's What To Make Of Nexen's (KRX:005720) 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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 Nexen (KRX:005720), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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 Nexen, this is the formula:

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

0.02 = ₩68b ÷ (₩4.2t - ₩819b) (Based on the trailing twelve months to September 2020).

Thus, Nexen has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 4.1%.

View our latest analysis for Nexen

Historical performance is a great place to start when researching a stock so above you can see the gauge for Nexen's ROCE against it's prior returns. If you're interested in investigating Nexen's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Nexen, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.0% from 11% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

Our Take On Nexen's ROCE

We're a bit apprehensive about Nexen because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last five years have experienced a 31% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we found 3 warning signs for Nexen (1 shouldn't be ignored) you should be aware of.

While Nexen 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. 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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