Returns On Capital At BW Energy (OB:BWE) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think BW Energy (OB:BWE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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. Analysts use this formula to calculate it for BW Energy:

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

0.026 = US$20m ÷ (US$836m - US$64m) (Based on the trailing twelve months to March 2021).

Therefore, BW Energy has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 7.2%.

See our latest analysis for BW Energy

Above you can see how the current ROCE for BW Energy compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for BW Energy.

What Does the ROCE Trend For BW Energy Tell Us?

When we looked at the ROCE trend at BW Energy, we didn't gain much confidence. Around two years ago the returns on capital were 12%, but since then they've fallen to 2.6%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

On a side note, BW Energy has done well to pay down its current liabilities to 7.7% 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.

What We Can Learn From BW Energy's ROCE

We're a bit apprehensive about BW Energy because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 42% return over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 1 warning sign for BW Energy you'll probably want to know about.

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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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