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Today we’ll look at Southwestern Energy Company (NYSE:SWN) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Southwestern Energy:
0.15 = US$817m ÷ (US$6.4b – US$943m) (Based on the trailing twelve months to March 2019.)
So, Southwestern Energy has an ROCE of 15%.
Does Southwestern Energy Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Southwestern Energy’s ROCE appears to be substantially greater than the 7.4% 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. Independently of how Southwestern Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Southwestern Energy currently has an ROCE of 15%, compared to its ROCE of 0.04% 3 years ago. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Southwestern 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 Southwestern Energy.
What Are Current Liabilities, And How Do They Affect Southwestern Energy’s 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Southwestern Energy has total assets of US$6.4b and current liabilities of US$943m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Southwestern Energy’s ROCE
Overall, Southwestern Energy has a decent ROCE and could be worthy of further research. There might be better investments than Southwestern 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.
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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.