Today we'll evaluate President Energy Plc (LON:PPC) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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.
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 President Energy:
0.072 = US$13m ÷ (US$215m - US$27m) (Based on the trailing twelve months to June 2019.)
So, President Energy has an ROCE of 7.2%.
Is President Energy's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, President Energy's ROCE appears to be significantly below the 9.8% average in the Oil and Gas industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, President Energy's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
President Energy has an ROCE of 7.2%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can click on the image below to see (in greater detail) how President Energy's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. We note President Energy could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How President Energy's Current Liabilities Impact Its 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 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.
President Energy has current liabilities of US$27m and total assets of US$215m. As a result, its current liabilities are equal to approximately 13% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On President Energy's ROCE
That said, President Energy's ROCE is mediocre, there may be more attractive investments around. 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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