What Can We Learn From Peyto Exploration & Development Corp.’s (TSE:PEY) Investment Returns?

Today we’ll evaluate Peyto Exploration & Development Corp. (TSE:PEY) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

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

ROCE measures the amount of pre-tax profits a company can generate from the 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.’

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 Peyto Exploration & Development:

0.056 = CA$200m ÷ (CA$3.7b – CA$77m) (Based on the trailing twelve months to March 2019.)

Therefore, Peyto Exploration & Development has an ROCE of 5.6%.

Check out our latest analysis for Peyto Exploration & Development

Does Peyto Exploration & Development Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Peyto Exploration & Development’s ROCE appears to be around the 5.5% average of the Oil and Gas industry. Separate from how Peyto Exploration & Development stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

TSX:PEY Past Revenue and Net Income, July 25th 2019
TSX:PEY Past Revenue and Net Income, July 25th 2019

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. Remember that most companies like Peyto Exploration & Development are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Peyto Exploration & Development.

What Are Current Liabilities, And How Do They Affect Peyto Exploration & Development’s 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Peyto Exploration & Development has total liabilities of CA$77m and total assets of CA$3.7b. Therefore its current liabilities are equivalent to approximately 2.1% of its total assets. Peyto Exploration & Development reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

The Bottom Line On Peyto Exploration & Development’s ROCE

Peyto Exploration & Development looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Peyto Exploration & Development. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 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. Thank you for reading.

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