Touchstone Exploration (TSE:TXP) Could Be Struggling To Allocate Capital
What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. However, after briefly looking over the numbers, we don't think Touchstone Exploration (TSE:TXP) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Touchstone Exploration:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0035 = US$432k ÷ (US$152m - US$29m) (Based on the trailing twelve months to June 2023).
Thus, Touchstone Exploration has an ROCE of 0.4%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 13%.
View our latest analysis for Touchstone Exploration
Above you can see how the current ROCE for Touchstone Exploration 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.
The Trend Of ROCE
We weren't thrilled with the trend because Touchstone Exploration's ROCE has reduced by 98% over the last five years, while the business employed 98% more capital. Usually this isn't ideal, but given Touchstone Exploration conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Touchstone Exploration's earnings and if they change as a result from the capital raise.
What We Can Learn From Touchstone Exploration's ROCE
Bringing it all together, while we're somewhat encouraged by Touchstone Exploration's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 215% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a final note, we've found 2 warning signs for Touchstone Exploration that we think you should be aware of.
While Touchstone Exploration isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
