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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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 when we looked at the ROCE trend of Parex Resources (TSE:PXT) we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Parex Resources, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.39 = US$618m ÷ (US$1.9b - US$340m) (Based on the trailing twelve months to March 2022).
Thus, Parex Resources has an ROCE of 39%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.
Above you can see how the current ROCE for Parex Resources compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
Parex Resources is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 39%. The amount of capital employed has increased too, by 84%. So we're very much inspired by what we're seeing at Parex Resources thanks to its ability to profitably reinvest capital.
The Key Takeaway
In summary, it's great to see that Parex Resources can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with a respectable 51% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. Therefore, we think it would be worth your time to check if these trends are going to continue.
Parex Resources does have some risks though, and we've spotted 2 warning signs for Parex Resources that you might be interested in.
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.