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Today we are going to look at Odfjell Drilling Ltd. (OB:ODL) to see whether it might be an attractive investment prospect. 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. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Odfjell Drilling:
0.072 = US$96m ÷ (US$2.3b – US$931m) (Based on the trailing twelve months to December 2018.)
So, Odfjell Drilling has an ROCE of 7.2%.
Is Odfjell Drilling’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Odfjell Drilling’s ROCE is around the 8.0% average reported by the Energy Services industry. Setting aside the industry comparison for now, Odfjell Drilling’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Odfjell Drilling’s current ROCE of 7.2% is lower than its ROCE in the past, which was 11%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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 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. Given the industry it operates in, Odfjell Drilling could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Odfjell Drilling.
Odfjell Drilling’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 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.
Odfjell Drilling has total assets of US$2.3b and current liabilities of US$931m. As a result, its current liabilities are equal to approximately 41% of its total assets. Odfjell Drilling’s ROCE is improved somewhat by its moderate amount of current liabilities.
The Bottom Line On Odfjell Drilling’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than Odfjell Drilling. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.