To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. 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 Epsilon Energy's (NASDAQ:EPSN) returns on capital, so let's have a look.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Epsilon Energy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.34 = US$35m ÷ (US$111m - US$8.8m) (Based on the trailing twelve months to June 2022).
Therefore, Epsilon Energy has an ROCE of 34%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Epsilon Energy's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Epsilon Energy, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
We're delighted to see that Epsilon Energy is reaping rewards from its investments and has now broken into profitability. The company now earns 34% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
What We Can Learn From Epsilon Energy's ROCE
To sum it up, Epsilon Energy is collecting higher returns from the same amount of capital, and that's impressive. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 36% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
One more thing to note, we've identified 2 warning signs with Epsilon Energy and understanding these should be part of your investment process.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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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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