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Be Wary Of Z Energy (NZSE:ZEL) And Its Returns On Capital

·2-min read

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Z Energy (NZSE:ZEL), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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 Z Energy is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.046 = NZ$97m ÷ (NZ$3.0b - NZ$859m) (Based on the trailing twelve months to March 2021).

Thus, Z Energy has an ROCE of 4.6%. In absolute terms, that's a low return, but it's much better than the Oil and Gas industry average of 2.3%.

View our latest analysis for Z Energy

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In the above chart we have measured Z 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.

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because Z Energy's ROCE has reduced by 67% over the last five years, while the business employed 118% more capital. That being said, Z Energy raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Z Energy's earnings and if they change as a result from the capital raise.

Our Take On Z Energy's ROCE

In summary, we're somewhat concerned by Z Energy's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 55% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 3 warning signs for Z Energy (2 don't sit too well with us) you should be aware of.

While Z Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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