If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Speaking of which, we noticed some great changes in Hurricane Energy's (LON:HUR) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Hurricane Energy:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$45m ÷ (US$355m - US$124m) (Based on the trailing twelve months to June 2022).
Therefore, Hurricane Energy has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 9.5% earned by companies in a similar industry.
In the above chart we have measured Hurricane 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 Hurricane Energy here for free.
How Are Returns Trending?
Like most people, we're pleased that Hurricane Energy is now generating some pretax earnings. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 20% on their capital employed. In regards to capital employed, Hurricane Energy is using 43% 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. This could potentially mean that the company is selling some of its assets.
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. Effectively this means that suppliers or short-term creditors are now funding 35% of the business, which is more than it was five years ago. 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.
In summary, it's great to see that Hurricane Energy has been able to turn things around and earn higher returns on lower amounts of capital. Although the company may be facing some issues elsewhere since the stock has plunged 77% in the last five years. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
If you'd like to know more about Hurricane Energy, we've spotted 3 warning signs, and 2 of them are significant.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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