Today we are going to look at Cabot Oil & Gas Corporation (NYSE:COG) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding 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. 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’.
How Do You Calculate Return On Capital Employed?
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 Cabot Oil & Gas:
0.21 = US$879m ÷ (US$4.5b – US$328m) (Based on the trailing twelve months to December 2019.)
So, Cabot Oil & Gas has an ROCE of 21%.
Is Cabot Oil & Gas’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Cabot Oil & Gas’s ROCE is meaningfully higher than the 8.0% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Cabot Oil & Gas’s ROCE in absolute terms currently looks quite high.
Cabot Oil & Gas reported an ROCE of 21% — 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 Cabot Oil & Gas’s ROCE compares to its industry. Click to see more on past growth.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Cabot Oil & Gas could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cabot Oil & Gas.
How Cabot Oil & Gas’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Cabot Oil & Gas has total assets of US$4.5b and current liabilities of US$328m. As a result, its current liabilities are equal to approximately 7.3% of its total assets. Minimal current liabilities are not distorting Cabot Oil & Gas’s impressive ROCE.
What We Can Learn From Cabot Oil & Gas’s ROCE
This should mark the company as worthy of further investigation. There might be better investments than Cabot Oil & Gas 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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