VAALCO Energy (NYSE:EGY) Is Reinvesting At Lower Rates Of Return

What trends should we look for it we want to identify stocks that can 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So while VAALCO Energy (NYSE:EGY) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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 VAALCO Energy, this is the formula:

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

0.28 = US$54m ÷ (US$309m - US$118m) (Based on the trailing twelve months to March 2022).

So, VAALCO Energy has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

Check out our latest analysis for VAALCO Energy

Above you can see how the current ROCE for VAALCO Energy 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 VAALCO Energy here for free.

How Are Returns Trending?

In terms of VAALCO Energy's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 59%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, VAALCO Energy has decreased its current liabilities to 38% of total assets. That could partly explain why the ROCE has dropped. 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. 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. And the stock has done incredibly well with a 872% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

On a final note, we found 3 warning signs for VAALCO Energy (2 are a bit concerning) you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.