Today we’ll look at SRC Energy Inc. (NYSEMKT:SRCI) and reflect on its potential as an investment. 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, 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 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. Ultimately, it is a useful but imperfect metric. 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’.
So, How Do We Calculate ROCE?
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 SRC Energy:
0.14 = US$354m ÷ (US$2.8b – US$265m) (Based on the trailing twelve months to June 2019.)
Therefore, SRC Energy has an ROCE of 14%.
Does SRC Energy Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that SRC Energy’s ROCE is meaningfully better than the 7.5% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from SRC Energy’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
SRC Energy delivered an ROCE of 14%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.
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 SRC Energy are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do SRC Energy’s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
SRC Energy has total assets of US$2.8b and current liabilities of US$265m. As a result, its current liabilities are equal to approximately 9.5% of its total assets. Low current liabilities have only a minimal impact on SRC Energy’s ROCE, making its decent returns more credible.
Our Take On SRC Energy’s ROCE
If SRC Energy can continue reinvesting in its business, it could be an attractive prospect. SRC Energy 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.
If you are like me, then you will 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 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. Thank you for reading.