Peyto Exploration & Development (TSE:PEY) May Have Issues Allocating Its Capital

When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after glancing at the trends within Peyto Exploration & Development (TSE:PEY), we weren't too hopeful.

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. Analysts use this formula to calculate it for Peyto Exploration & Development:

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

0.024 = CA$84m ÷ (CA$3.7b - CA$130m) (Based on the trailing twelve months to March 2021).

Therefore, Peyto Exploration & Development has an ROCE of 2.4%. On its own that's a low return on capital but it's in line with the industry's average returns of 2.4%.

View our latest analysis for Peyto Exploration & Development

roce

In the above chart we have measured Peyto Exploration & Development's 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 Peyto Exploration & Development here for free.

So How Is Peyto Exploration & Development's ROCE Trending?

There is reason to be cautious about Peyto Exploration & Development, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 7.2% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Peyto Exploration & Development becoming one if things continue as they have.

The Bottom Line On Peyto Exploration & Development's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. This could explain why the stock has sunk a total of 75% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Peyto Exploration & Development (including 2 which are a bit concerning) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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.