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Today we’ll evaluate Carrizo Oil & Gas, Inc. (NASDAQ:CRZO) 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.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Carrizo Oil & Gas:
0.091 = US$178m ÷ (US$2.9b – US$556m) (Based on the trailing twelve months to September 2018.)
Therefore, Carrizo Oil & Gas has an ROCE of 9.1%.
Is Carrizo Oil & Gas’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Carrizo Oil & Gas’s ROCE appears to be substantially greater than the 6.1% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Aside from the industry comparison, Carrizo Oil & Gas’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
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 only a point-in-time measure. We note Carrizo Oil & Gas could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Carrizo Oil & Gas.
How Carrizo Oil & Gas’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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Carrizo Oil & Gas has total liabilities of US$556m and total assets of US$2.9b. Therefore its current liabilities are equivalent to approximately 19% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Carrizo Oil & Gas’s ROCE
That said, Carrizo Oil & Gas’s ROCE is mediocre, there may be more attractive investments around. But note: Carrizo Oil & Gas may not be the best stock to buy. 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.