Here's What Diversified Gas & Oil PLC's (LON:DGOC) ROCE Can Tell Us

Today we'll look at Diversified Gas & Oil PLC (LON:DGOC) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Diversified Gas & Oil:

0.13 = US$241m ÷ (US$1.9b - US$59m) (Based on the trailing twelve months to June 2019.)

Therefore, Diversified Gas & Oil has an ROCE of 13%.

Check out our latest analysis for Diversified Gas & Oil

Is Diversified Gas & Oil's ROCE Good?

One way to assess ROCE is to compare similar companies. Diversified Gas & Oil's ROCE appears to be substantially greater than the 10% average in the Oil and Gas industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Diversified Gas & Oil sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Diversified Gas & Oil reported an ROCE of 13% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can see in the image below how Diversified Gas & Oil's ROCE compares to its industry.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Given the industry it operates in, Diversified Gas & Oil could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Diversified Gas & Oil's Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

Diversified Gas & Oil has total assets of US$1.9b and current liabilities of US$59m. Therefore its current liabilities are equivalent to approximately 3.0% of its total assets. Low current liabilities have only a minimal impact on Diversified Gas & Oil's ROCE, making its decent returns more credible.

The Bottom Line On Diversified Gas & Oil's ROCE

This is good to see, and while better prospects may exist, Diversified Gas & Oil seems worth researching further. Diversified Gas & Oil shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.