Today we’ll look at Hindustan Oil Exploration Company Limited (NSE:HINDOILEXP) 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. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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’.
How Do You Calculate Return On Capital Employed?
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 Hindustan Oil Exploration:
0.19 = ₹1.4b ÷ (₹8.4b – ₹978m) (Based on the trailing twelve months to September 2019.)
Therefore, Hindustan Oil Exploration has an ROCE of 19%.
Is Hindustan Oil Exploration’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Hindustan Oil Exploration’s ROCE is meaningfully better than the 10.0% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Hindustan Oil Exploration sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Hindustan Oil Exploration delivered an ROCE of 19%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how Hindustan Oil Exploration’s ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 Hindustan Oil Exploration are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Hindustan Oil Exploration’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 counter this, investors can check if a company has high current liabilities relative to total assets.
Hindustan Oil Exploration has total assets of ₹8.4b and current liabilities of ₹978m. As a result, its current liabilities are equal to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Hindustan Oil Exploration’s ROCE
Overall, Hindustan Oil Exploration has a decent ROCE and could be worthy of further research. Hindustan Oil Exploration 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.
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 firstname.lastname@example.org. 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.
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. Thank you for reading.