Today we’ll look at Schlumberger Limited (NYSE:SLB) 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.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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 measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Schlumberger:
0.051 = US$3.0b ÷ (US$71b – US$12b) (Based on the trailing twelve months to June 2019.)
So, Schlumberger has an ROCE of 5.1%.
Is Schlumberger’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Schlumberger’s ROCE is meaningfully below the Energy Services industry average of 9.8%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Schlumberger compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. Readers may wish to look for more rewarding investments.
You can click on the image below to see (in greater detail) how Schlumberger’s past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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. We note Schlumberger could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Schlumberger.
Do Schlumberger’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Schlumberger has total assets of US$71b and current liabilities of US$12b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Schlumberger’s ROCE
While that is good to see, Schlumberger has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Schlumberger better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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. Thank you for reading.