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Today we’ll evaluate TransGlobe Energy Corporation (NASDAQ:TGA) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?
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 TransGlobe Energy:
0.17 = US$47m ÷ (US$308m – US$30m) (Based on the trailing twelve months to March 2019.)
So, TransGlobe Energy has an ROCE of 17%.
Is TransGlobe Energy’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that TransGlobe Energy’s ROCE is meaningfully better than the 7.4% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how TransGlobe Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
TransGlobe Energy delivered an ROCE of 17%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
When considering this metric, keep in mind that it is backwards looking, and 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. Given the industry it operates in, TransGlobe Energy 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 TransGlobe Energy.
Do TransGlobe Energy’s Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
TransGlobe Energy has total assets of US$308m and current liabilities of US$30m. As a result, its current liabilities are equal to approximately 9.6% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), TransGlobe Energy earns a sound return on capital employed.
Our Take On TransGlobe Energy’s ROCE
If TransGlobe Energy can continue reinvesting in its business, it could be an attractive prospect. There might be better investments than TransGlobe Energy out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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. Thank you for reading.