Investors Should Be Encouraged By Galp Energia SGPS' (ELI:GALP) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out 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. With that in mind, the ROCE of Galp Energia SGPS (ELI:GALP) looks great, so lets see what the trend can tell us.

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. Analysts use this formula to calculate it for Galp Energia SGPS:

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

0.22 = €2.6b ÷ (€18b - €6.2b) (Based on the trailing twelve months to September 2022).

Therefore, Galp Energia SGPS has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 15%.

Check out the opportunities and risks within the XX Oil and Gas industry.

Above you can see how the current ROCE for Galp Energia SGPS compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Galp Energia SGPS here for free.

What Does the ROCE Trend For Galp Energia SGPS Tell Us?

The trends we've noticed at Galp Energia SGPS are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 22%. The amount of capital employed has increased too, by 29%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 34% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line

To sum it up, Galp Energia SGPS has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. With that in mind, we believe the promising trends warrant this stock for further investigation.

Galp Energia SGPS does have some risks, we noticed 2 warning signs (and 1 which is a bit concerning) we think you should know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.