Capital Allocation Trends At VAALCO Energy (NYSE:EGY) Aren't Ideal

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Although, when we looked at VAALCO Energy (NYSE:EGY), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on VAALCO Energy is:

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

0.16 = US$106m ÷ (US$829m - US$154m) (Based on the trailing twelve months to June 2023).

Therefore, VAALCO Energy has an ROCE of 16%. In absolute terms, that's a pretty standard return but compared to the Oil and Gas industry average it falls behind.

See our latest analysis for VAALCO Energy

In the above chart we have measured VAALCO Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering VAALCO Energy here for free.

What Does the ROCE Trend For VAALCO Energy Tell Us?

On the surface, the trend of ROCE at VAALCO Energy doesn't inspire confidence. Around five years ago the returns on capital were 57%, but since then they've fallen to 16%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, VAALCO Energy has decreased its current liabilities to 19% 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.

Our Take On VAALCO Energy's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for VAALCO Energy. Furthermore the stock has climbed 70% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we found 3 warning signs for VAALCO Energy (1 makes us a bit uncomfortable) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.