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Today we'll look at Adams Resources & Energy, Inc. (NYSEMKT:AE) 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. Then we'll compare its ROCE 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 Adams Resources & Energy:
0.025 = US$4.3m ÷ (US$315m - US$145m) (Based on the trailing twelve months to March 2019.)
So, Adams Resources & Energy has an ROCE of 2.5%.
Does Adams Resources & Energy Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Adams Resources & Energy's ROCE appears meaningfully below the 7.6% average reported by the Oil and Gas industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Adams Resources & Energy stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
Adams Resources & Energy delivered an ROCE of 2.5%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. We note Adams Resources & Energy could be considered a cyclical business. You can check if Adams Resources & Energy has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Adams Resources & Energy'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Adams Resources & Energy has total assets of US$315m and current liabilities of US$145m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Adams Resources & Energy's ROCE is concerning.
Our Take On Adams Resources & Energy's ROCE
So researching other companies may be a better use of your time. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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 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.