Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. So on that note, Phillips 66 (NYSE:PSX) looks quite promising in regards to its trends of return on capital.
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. The formula for this calculation on Phillips 66 is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$9.7b ÷ (US$76b - US$16b) (Based on the trailing twelve months to December 2022).
Therefore, Phillips 66 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.
Above you can see how the current ROCE for Phillips 66 compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Phillips 66.
What Can We Tell From Phillips 66's ROCE Trend?
We like the trends that we're seeing from Phillips 66. Over the last five years, returns on capital employed have risen substantially to 16%. The amount of capital employed has increased too, by 37%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
To sum it up, Phillips 66 has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has only returned 21% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
One final note, you should learn about the 3 warning signs we've spotted with Phillips 66 (including 1 which is a bit unpleasant) .
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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