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Today we’ll look at Eland Oil & Gas PLC (LON:ELA) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Eland Oil & Gas:
0.21 = US$79m ÷ (US$474m – US$101m) (Based on the trailing twelve months to December 2018.)
Therefore, Eland Oil & Gas has an ROCE of 21%.
Is Eland Oil & Gas’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Eland Oil & Gas’s ROCE appears to be substantially greater than the 7.6% 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. Regardless of the industry comparison, in absolute terms, Eland Oil & Gas’s ROCE currently appears to be excellent.
Eland Oil & Gas reported an ROCE of 21% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. Remember that most companies like Eland Oil & Gas are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Eland Oil & Gas.
Do Eland Oil & Gas’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Eland Oil & Gas has total assets of US$474m and current liabilities of US$101m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From Eland Oil & Gas’s ROCE
Low current liabilities and high ROCE is a good combination, making Eland Oil & Gas look quite interesting. Eland Oil & Gas looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Eland Oil & Gas better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.