Today we’ll look at Goodrich Petroleum Corporation (NYSEMKT:GDP) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Goodrich Petroleum:
0.19 = US$36m ÷ (US$235m – US$46m) (Based on the trailing twelve months to September 2019.)
So, Goodrich Petroleum has an ROCE of 19%.
Is Goodrich Petroleum’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Goodrich Petroleum’s ROCE is meaningfully higher than the 8.9% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Goodrich Petroleum compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how Goodrich Petroleum’s ROCE compares to its industry.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. We note Goodrich Petroleum could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Goodrich Petroleum’s Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Goodrich Petroleum has total liabilities of US$46m and total assets of US$235m. As a result, its current liabilities are equal to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Goodrich Petroleum’s ROCE
Overall, Goodrich Petroleum has a decent ROCE and could be worthy of further research. There might be better investments than Goodrich Petroleum out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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