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. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Tap Oil (ASX:TAP) looks quite promising in regards to its trends of return on capital.
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. The formula for this calculation on Tap Oil is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = US$5.3m ÷ (US$84m - US$12m) (Based on the trailing twelve months to December 2019).
Therefore, Tap Oil has an ROCE of 7.3%. Even though it's in line with the industry average of 7.4%, it's still a low return by itself.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Tap Oil's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is Tap Oil's ROCE Trending?
It's great to see that Tap Oil has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 7.3% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 60% 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. This could potentially mean that the company is selling some of its assets.
The Key Takeaway
In the end, Tap Oil has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has fallen 63% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Tap Oil (of which 1 doesn't sit too well with us!) that you should know about.
While Tap Oil 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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