Today we are going to look at Confidence Petroleum India Limited (NSE:CONFIPET) to see whether it might be an attractive investment prospect. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.
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 Confidence Petroleum India:
0.15 = ₹918m ÷ (₹6.7b – ₹555m) (Based on the trailing twelve months to December 2019.)
So, Confidence Petroleum India has an ROCE of 15%.
Is Confidence Petroleum India’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Confidence Petroleum India’s ROCE is around the 13% average reported by the Machinery industry. Independently of how Confidence Petroleum India compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Confidence Petroleum India currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 6.4%. This makes us wonder if the company is improving. You can see in the image below how Confidence Petroleum India’s ROCE compares to its industry. Click to see more on past growth.
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 only a point-in-time measure. You can check if Confidence Petroleum India has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Confidence Petroleum India’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Confidence Petroleum India has current liabilities of ₹555m and total assets of ₹6.7b. As a result, its current liabilities are equal to approximately 8.2% of its total assets. Low current liabilities have only a minimal impact on Confidence Petroleum India’s ROCE, making its decent returns more credible.
Our Take On Confidence Petroleum India’s ROCE
This is good to see, and while better prospects may exist, Confidence Petroleum India seems worth researching further. Confidence Petroleum India shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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