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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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at Australis Oil & Gas (ASX:ATS) so let's look a bit deeper.
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. Analysts use this formula to calculate it for Australis Oil & Gas:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = US$9.3m ÷ (US$230m - US$17m) (Based on the trailing twelve months to December 2019).
Therefore, Australis Oil & Gas has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 7.3%.
Above you can see how the current ROCE for Australis Oil & Gas compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Australis Oil & Gas here for free.
How Are Returns Trending?
We're delighted to see that Australis Oil & Gas is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses four years ago, but now it's earning 4.3% which is a sight for sore eyes. Not only that, but the company is utilizing 760% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
What We Can Learn From Australis Oil & Gas' ROCE
Long story short, we're delighted to see that Australis Oil & Gas' reinvestment activities have paid off and the company is now profitable. However the stock is down a substantial 86% in the last three 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.
One more thing: We've identified 4 warning signs with Australis Oil & Gas (at least 2 which can't be ignored) , and understanding them would certainly be useful.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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