If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. So when we looked at Valaris (NYSE:VAL) and its trend of ROCE, we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

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 Valaris is:

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

0.079 = US$287m ÷ (US$4.3b - US$692m) (Based on the trailing twelve months to September 2024).

So, Valaris has an ROCE of 7.9%. Ultimately, that's a low return and it under-performs the Energy Services industry average of 10%.

View our latest analysis for Valaris

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%. Valaris could be selling under-performing assets since the ROCE is improving.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 16% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On Valaris' ROCE

In the end, Valaris has proven it's capital allocation skills are good with those higher returns from less amount of capital. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 27% return over the last three years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Valaris does have some risks though, and we've spotted 2 warning signs for Valaris that you might be interested in.

While Valaris may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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