If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Epsilon Energy (NASDAQ:EPSN) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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. To calculate this metric for Epsilon Energy, this is the formula:

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

0.054 = US$6.2m ÷ (US$122m - US$7.3m) (Based on the trailing twelve months to September 2024).

Thus, Epsilon Energy has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 12%.

Check out our latest analysis for Epsilon Energy

In the above chart we have measured Epsilon 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 analyst report for Epsilon Energy .

What The Trend Of ROCE Can Tell Us

In terms of Epsilon Energy's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 11%, but since then they've fallen to 5.4%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Epsilon Energy have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these poor fundamentals, the stock has gained a huge 115% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One final note, you should learn about the 3 warning signs we've spotted with Epsilon Energy (including 2 which are concerning) .

While Epsilon Energy 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.

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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.