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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Epsilon Energy (NASDAQ:EPSN) so let's look a bit deeper.
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 Epsilon Energy:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.019 = US$1.5m ÷ (US$87m - US$4.5m) (Based on the trailing twelve months to December 2020).
So, Epsilon Energy has an ROCE of 1.9%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 7.9%.
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 Epsilon Energy's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
It's great to see that Epsilon Energy has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 1.9% which is no doubt a relief for some early shareholders. In regards to capital employed, Epsilon Energy is using 25% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.
The Bottom Line
In a nutshell, we're pleased to see that Epsilon Energy has been able to generate higher returns from less capital. And since the stock has fallen 27% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
On a separate note, we've found 2 warning signs for Epsilon Energy you'll probably want to know about.
While Epsilon Energy may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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