Are GeoPark Limited’s (NYSE:GPRK) High Returns Really That Great?

Today we’ll look at GeoPark Limited (NYSE:GPRK) 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. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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’.

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 GeoPark:

0.28 = US\$76m ÷ (US\$867m – US\$188m) (Based on the trailing twelve months to September 2018.)

So, GeoPark has an ROCE of 28%.

Does GeoPark Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that GeoPark’s ROCE is meaningfully better than the 5.6% 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. Setting aside the comparison to its industry for a moment, GeoPark’s ROCE in absolute terms currently looks quite high.

GeoPark has an ROCE of 28%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.

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, GeoPark could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for GeoPark.

How GeoPark’s Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

GeoPark has total liabilities of US\$188m and total assets of US\$867m. As a result, its current liabilities are equal to approximately 22% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

What We Can Learn From GeoPark’s ROCE

With low current liabilities and a high ROCE, GeoPark could be worthy of further investigation. But note: GeoPark 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).

I will like GeoPark better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 editorial-team@simplywallst.com.