What Can We Make Of ConocoPhillips’s (NYSE:COP) High Return On Capital?

Today we are going to look at ConocoPhillips (NYSE:COP) 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.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 ConocoPhillips:

0.12 = US$7.4b ÷ (US$71b – US$7.0b) (Based on the trailing twelve months to December 2019.)

So, ConocoPhillips has an ROCE of 12%.

View our latest analysis for ConocoPhillips

Does ConocoPhillips Have A Good ROCE?

One way to assess ROCE is to compare similar companies. ConocoPhillips’s ROCE appears to be substantially greater than the 7.1% 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. Separate from ConocoPhillips’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

ConocoPhillips delivered an ROCE of 12%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how ConocoPhillips’s ROCE compares to its industry. Click to see more on past growth.

NYSE:COP Past Revenue and Net Income April 3rd 2020
NYSE:COP Past Revenue and Net Income April 3rd 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, ConocoPhillips 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 ConocoPhillips’s Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

ConocoPhillips has total assets of US$71b and current liabilities of US$7.0b. As a result, its current liabilities are equal to approximately 10.0% of its total assets. Low current liabilities have only a minimal impact on ConocoPhillips’s ROCE, making its decent returns more credible.

Our Take On ConocoPhillips’s ROCE

If it is able to keep this up, ConocoPhillips could be attractive. ConocoPhillips 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.

I will like ConocoPhillips better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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