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What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base 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. Having said that, after a brief look, Gulf Keystone Petroleum (LON:GKP) we aren't filled with optimism, but let's investigate further.
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. The formula for this calculation on Gulf Keystone Petroleum is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0056 = US$3.1m ÷ (US$668m - US$118m) (Based on the trailing twelve months to December 2024).
Therefore, Gulf Keystone Petroleum has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 9.6%.
See our latest analysis for Gulf Keystone Petroleum
Above you can see how the current ROCE for Gulf Keystone Petroleum compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Gulf Keystone Petroleum .
What Can We Tell From Gulf Keystone Petroleum's ROCE Trend?
There is reason to be cautious about Gulf Keystone Petroleum, given the returns are trending downwards. About five years ago, returns on capital were 7.4%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Gulf Keystone Petroleum to turn into a multi-bagger.
In Conclusion...
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 314%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.