Today we are going to look at GeoPark Limited (NYSE:GPRK) to see whether it might be an attractive investment prospect. 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. Then we’ll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. 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?
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 GeoPark:
0.41 = US$258m ÷ (US$793m – US$158m) (Based on the trailing twelve months to September 2019.)
Therefore, GeoPark has an ROCE of 41%.
Does GeoPark Have A Good ROCE?
One way to assess ROCE is to compare similar companies. GeoPark’s ROCE appears to be substantially greater than the 9.0% 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 the industry comparison, in absolute terms, GeoPark’s ROCE currently appears to be excellent.
GeoPark reported an ROCE of 41% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how GeoPark’s past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. Remember that most companies like GeoPark are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
GeoPark’s Current Liabilities And Their Impact On 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.
GeoPark has current liabilities of US$158m and total assets of US$793m. As a result, its current liabilities are equal to approximately 20% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On GeoPark’s ROCE
Low current liabilities and high ROCE is a good combination, making GeoPark look quite interesting. There might be better investments than GeoPark 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 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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