What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at CF Energy (CVE:CFY) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
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 CF Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = CN¥60m ÷ (CN¥1.1b - CN¥343m) (Based on the trailing twelve months to June 2021).
Therefore, CF Energy has an ROCE of 8.3%. On its own that's a low return, but compared to the average of 5.4% generated by the Gas Utilities industry, it's much better.
Historical performance is a great place to start when researching a stock so above you can see the gauge for CF Energy's ROCE against it's prior returns. If you're interested in investigating CF Energy's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is CF Energy's ROCE Trending?
Unfortunately, the trend isn't great with ROCE falling from 18% five years ago, while capital employed has grown 161%. Usually this isn't ideal, but given CF Energy conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. CF Energy probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.
On a side note, CF Energy has done well to pay down its current liabilities to 32% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On CF Energy's ROCE
Bringing it all together, while we're somewhat encouraged by CF Energy's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 105% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a final note, we found 3 warning signs for CF Energy (2 are a bit concerning) you should be aware of.
While CF Energy may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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