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To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 Tullow Oil's (LON:TLW) returns on capital, so let's have a look.
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. To calculate this metric for Tullow Oil, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$504m ÷ (US$5.5b - US$1.3b) (Based on the trailing twelve months to December 2021).
Thus, Tullow Oil has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Oil and Gas industry average of 5.7% it's much better.
See our latest analysis for Tullow Oil
Above you can see how the current ROCE for Tullow Oil compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Tullow Oil's ROCE Trending?
We're delighted to see that Tullow Oil is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but now it's turned around, earning 12% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 54% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. 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 summary, it's great to see that Tullow Oil has been able to turn things around and earn higher returns on lower amounts of capital. However the stock is down a substantial 71% in the last five years so there could be other areas of the business hurting its prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.
On a final note, we've found 1 warning sign for Tullow Oil that we think you should be aware of.