If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Baker Hughes (NASDAQ:BKR) and its trend of ROCE, we really liked what we saw.
What Is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for Baker Hughes:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$3.0b ÷ (US$37b - US$13b) (Based on the trailing twelve months to June 2024).
Therefore, Baker Hughes has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 11% generated by the Energy Services industry.
In the above chart we have measured Baker Hughes' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Baker Hughes .
So How Is Baker Hughes' ROCE Trending?
Baker Hughes has not disappointed in regards to ROCE growth. The data shows that returns on capital have increased by 284% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 45% less than it was five years ago, which can be indicative of a business that's improving its efficiency. Baker Hughes may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 34% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. 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 Baker Hughes' ROCE
In a nutshell, we're pleased to see that Baker Hughes has been able to generate higher returns from less capital. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 75% return over the last five years. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing to note, we've identified 1 warning sign with Baker Hughes and understanding this should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
