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Today we’ll look at Tengasco, Inc. (NYSEMKT:TGC) 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.
What is Return On Capital Employed (ROCE)?
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. 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?
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 Tengasco:
0.05 = -US$765.0k ÷ (US$10m – US$830k) (Based on the trailing twelve months to September 2018.)
Therefore, Tengasco has an ROCE of 5.0%.
Does Tengasco Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Tengasco’s ROCE is fairly close to the Oil and Gas industry average of 6.2%. Putting aside Tengasco’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
Tengasco has an ROCE of 5.0%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been 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. Remember that most companies like Tengasco are cyclical businesses. If Tengasco is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Tengasco’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.
Tengasco has total liabilities of US$830k and total assets of US$10m. As a result, its current liabilities are equal to approximately 8.2% of its total assets. With barely any current liabilities, there is minimal impact on Tengasco’s admittedly low ROCE.
The Bottom Line On Tengasco’s ROCE
Nevertheless, there are potentially more attractive companies to invest in. You might be able to find a better buy than Tengasco. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Tengasco 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 email@example.com.