Today we’ll evaluate Talos Energy Inc. (NYSE:TALO) to determine whether it could have potential as an investment idea. 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.
What is 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?
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 Talos Energy:
0.20 = US$418m ÷ (US$2.6b – US$458m) (Based on the trailing twelve months to June 2019.)
Therefore, Talos Energy has an ROCE of 20%.
Does Talos Energy Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Talos Energy’s ROCE is meaningfully better than the 8.3% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Talos Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Talos Energy’s ROCE compares to its industry.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Talos Energy are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Talos Energy’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Talos Energy has total assets of US$2.6b and current liabilities of US$458m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Talos Energy’s ROCE
With that in mind, Talos Energy’s ROCE appears pretty good. Talos Energy 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.
I will like Talos Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.