Why We Like ConocoPhillips’s (NYSE:COP) 15% Return On Capital Employed

Today we’ll look at ConocoPhillips (NYSE:COP) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. 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.’

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 ConocoPhillips:

0.15 = US$9.6b ÷ (US$71b – US$7.4b) (Based on the trailing twelve months to March 2019.)

Therefore, ConocoPhillips has an ROCE of 15%.

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

See our latest analysis for ConocoPhillips

Is ConocoPhillips’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, ConocoPhillips’s ROCE is meaningfully higher than the 7.7% average in the Oil and Gas industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where ConocoPhillips sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

ConocoPhillips has an ROCE of 15%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.

NYSE:COP Past Revenue and Net Income, May 21st 2019
NYSE:COP Past Revenue and Net Income, May 21st 2019

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, after all, simply a snap shot of a single year. Given the industry it operates in, ConocoPhillips could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for ConocoPhillips.

ConocoPhillips’s Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

ConocoPhillips has total assets of US$71b and current liabilities of US$7.4b. As a result, its current liabilities are equal to approximately 10% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From ConocoPhillips’s ROCE

This is good to see, and with a sound ROCE, ConocoPhillips could be worth a closer look. ConocoPhillips 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).

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 editorial-team@simplywallst.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.