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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after briefly looking over the numbers, we don't think Magnolia Oil & Gas (NYSE:MGY) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
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 Magnolia Oil & Gas:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$137m ÷ (US$1.5b - US$126m) (Based on the trailing twelve months to March 2021).
Thus, Magnolia Oil & Gas has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Oil and Gas industry average of 8.0% it's much better.
In the above chart we have measured Magnolia Oil & Gas' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
In terms of Magnolia Oil & Gas' historical ROCE movements, the trend isn't fantastic. Around three years ago the returns on capital were 13%, but since then they've fallen to 10%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Magnolia Oil & Gas' ROCE
We're a bit apprehensive about Magnolia Oil & Gas because despite more capital being deployed in the business, returns on that capital and sales have both fallen. In spite of that, the stock has delivered a 13% return to shareholders who held over the last three years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
If you want to continue researching Magnolia Oil & Gas, you might be interested to know about the 1 warning sign that our analysis has discovered.
While Magnolia Oil & Gas isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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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