To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. With that in mind, we've noticed some promising trends at Valaris (NYSE:VAL) so let's look a bit deeper.
Return On Capital Employed (ROCE): What Is It?
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 Valaris, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = US$182m ÷ (US$4.4b - US$708m) (Based on the trailing twelve months to June 2024).
So, Valaris has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 11%.
In the above chart we have measured Valaris' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Valaris for free.
How Are Returns Trending?
It's great to see that Valaris has started to generate some pre-tax earnings from prior investments. While the business is profitable now, it used to be incurring losses on invested capital five years ago. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 78%. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.
The Bottom Line
In summary, it's great to see that Valaris has been able to turn things around and earn higher returns on lower amounts of capital. Since the stock has returned a solid 81% to shareholders over the last three years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
Valaris does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.
While Valaris 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.
