What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. And in light of that, the trends we're seeing at Peabody Energy's (NYSE:BTU) look very promising so lets take a look.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on Peabody Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.28 = US$1.2b ÷ (US$5.4b - US$1.3b) (Based on the trailing twelve months to September 2022).
So, Peabody Energy has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 21%.
In the above chart we have measured Peabody Energy's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Peabody Energy's ROCE Trending?
We're pretty happy with how the ROCE has been trending at Peabody Energy. The figures show that over the last five years, returns on capital have grown by 195%. The company is now earning US$0.3 per dollar of capital employed. Interestingly, the business may be becoming more efficient because it's applying 41% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 24% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
What We Can Learn From Peabody Energy's ROCE
In the end, Peabody Energy has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has fallen 25% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
Peabody Energy does have some risks, we noticed 4 warning signs (and 2 which are potentially serious) we think you should know about.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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