Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we'll evaluate Archrock, Inc. (NYSE:AROC) 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 up, we'll look at what ROCE is and how we calculate it. 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from 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?
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 Archrock:
0.071 = US$175m ÷ (US$2.6b - US$165m) (Based on the trailing twelve months to March 2019.)
So, Archrock has an ROCE of 7.1%.
Is Archrock's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Archrock's ROCE is meaningfully below the Energy Services industry average of 8.9%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Archrock stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Our data shows that Archrock currently has an ROCE of 7.1%, compared to its ROCE of 5.0% 3 years ago. This makes us wonder if the company is improving.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. We note Archrock could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Archrock.
What Are Current Liabilities, And How Do They Affect Archrock's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Archrock has total liabilities of US$165m and total assets of US$2.6b. Therefore its current liabilities are equivalent to approximately 6.3% of its total assets. With low levels of current liabilities, at least Archrock's mediocre ROCE is not unduly boosted.
Our Take On Archrock's ROCE
Archrock looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than Archrock. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Archrock 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.