Today we’ll look at Tamarack Valley Energy Ltd (TSE:TVE) and reflect on its potential as an investment. 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. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.’
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 Tamarack Valley Energy:
0.05 = CA$65m ÷ (CA$1.3b – CA$45m) (Based on the trailing twelve months to June 2019.)
Therefore, Tamarack Valley Energy has an ROCE of 5.0%.
Is Tamarack Valley Energy’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Tamarack Valley Energy’s ROCE is fairly close to the Oil and Gas industry average of 5.7%. Setting aside the industry comparison for now, Tamarack Valley Energy’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Tamarack Valley Energy reported an ROCE of 5.0% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Tamarack Valley 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.
Tamarack Valley Energy’s Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Tamarack Valley Energy has total liabilities of CA$45m and total assets of CA$1.3b. Therefore its current liabilities are equivalent to approximately 3.4% of its total assets. Tamarack Valley Energy has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On Tamarack Valley Energy’s ROCE
Tamarack Valley Energy looks like an ok business, but on this analysis it is not at the top of our buy list. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
Tamarack Valley Energy is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. Thank you for reading.