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What Can We Make Of Cimarex Energy Co.’s (NYSE:XEC) High Return On Capital?

Simply Wall St

Today we'll evaluate Cimarex Energy Co. (NYSE:XEC) to determine whether it could have potential as an investment idea. 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, we'll go over how we 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.

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. Generally speaking a higher ROCE is better. 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'.

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 Cimarex Energy:

0.11 = US$784m ÷ (US$7.6b - US$797m) (Based on the trailing twelve months to September 2019.)

So, Cimarex Energy has an ROCE of 11%.

See our latest analysis for Cimarex Energy

Does Cimarex Energy Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, Cimarex Energy's ROCE is meaningfully higher than the 9.0% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Cimarex Energy sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Cimarex Energy currently has an ROCE of 11%, compared to its ROCE of 2.5% 3 years ago. This makes us think the business might be improving. You can see in the image below how Cimarex Energy's ROCE compares to its industry. Click to see more on past growth.

NYSE:XEC Past Revenue and Net Income, January 22nd 2020
NYSE:XEC Past Revenue and Net Income, January 22nd 2020

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. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Cimarex 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.

What Are Current Liabilities, And How Do They Affect Cimarex Energy's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

Cimarex Energy has total assets of US$7.6b and current liabilities of US$797m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Cimarex Energy's ROCE

This is good to see, and with a sound ROCE, Cimarex Energy could be worth a closer look. Cimarex Energy looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like Cimarex 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.