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Today we’ll evaluate Tamarack Valley Energy Ltd (TSE:TVE) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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 Tamarack Valley Energy:
0.017 = -CA$4.8m ÷ (CA$1.3b – CA$93m) (Based on the trailing twelve months to September 2018.)
Therefore, Tamarack Valley Energy has an ROCE of 1.7%.
Is Tamarack Valley Energy’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Tamarack Valley Energy’s ROCE appears meaningfully below the 4.9% average reported by the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Tamarack Valley Energy compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. It is likely that there are more attractive prospects out there.
Tamarack Valley Energy has an ROCE of 1.7%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Tamarack Valley Energy are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Tamarack Valley Energy.
How Tamarack Valley Energy’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Tamarack Valley Energy has total liabilities of CA$93m and total assets of CA$1.3b. As a result, its current liabilities are equal to approximately 7.2% of its total assets. With barely any current liabilities, there is minimal impact on Tamarack Valley Energy’s admittedly low ROCE.
The Bottom Line On Tamarack Valley Energy’s ROCE
Nevertheless, there are potentially more attractive companies to invest in. But note: Tamarack Valley Energy may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.