Don’t Buy Orbit Garant Drilling Inc. (TSE:OGD) Until You Understand Its ROCE

Today we’ll look at Orbit Garant Drilling Inc. (TSE:OGD) and reflect on its potential as an investment. 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. 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.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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’.

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 Orbit Garant Drilling:

0.022 = CA$2.3m ÷ (CA$131m – CA$24m) (Based on the trailing twelve months to December 2018.)

So, Orbit Garant Drilling has an ROCE of 2.2%.

View our latest analysis for Orbit Garant Drilling

Does Orbit Garant Drilling Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Orbit Garant Drilling’s ROCE is around the 2.3% average reported by the Metals and Mining industry. Independently of how Orbit Garant Drilling compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. Readers may wish to look for more rewarding investments.

Orbit Garant Drilling reported an ROCE of 2.2% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.

TSX:OGD Past Revenue and Net Income, April 24th 2019
TSX:OGD Past Revenue and Net Income, April 24th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Orbit Garant Drilling are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Orbit Garant Drilling.

What Are Current Liabilities, And How Do They Affect Orbit Garant Drilling’s 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 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.

Orbit Garant Drilling has total assets of CA$131m and current liabilities of CA$24m. As a result, its current liabilities are equal to approximately 18% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

The Bottom Line On Orbit Garant Drilling’s ROCE

While that is good to see, Orbit Garant Drilling has a low ROCE and does not look attractive in this analysis. Of course, you might also be able to find a better stock than Orbit Garant Drilling. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.