Today we'll look at China Oilfield Services Limited (HKG:2883) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 China Oilfield Services:
0.065 = CN¥3.6b ÷ (CN¥77b - CN¥21b) (Based on the trailing twelve months to September 2019.)
So, China Oilfield Services has an ROCE of 6.5%.
Is China Oilfield Services's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, China Oilfield Services's ROCE appears meaningfully below the 14% average reported by the Energy Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, China Oilfield Services's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
China Oilfield Services reported an ROCE of 6.5% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how China Oilfield Services's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. We note China Oilfield Services could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Oilfield Services.
How China Oilfield Services's Current Liabilities Impact 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.
China Oilfield Services has total assets of CN¥77b and current liabilities of CN¥21b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From China Oilfield Services's ROCE
That said, China Oilfield Services's ROCE is mediocre, there may be more attractive investments around. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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. Thank you for reading.