Today we are going to look at CNOOC Limited (HKG:883) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 CNOOC:
0.13 = CN¥78b ÷ (CN¥679b - CN¥70b) (Based on the trailing twelve months to December 2018.)
So, CNOOC has an ROCE of 13%.
Is CNOOC's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, CNOOC's ROCE is meaningfully higher than the 7.4% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from CNOOC's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that CNOOC currently has an ROCE of 13%, compared to its ROCE of 2.7% 3 years ago. This makes us wonder if the company is improving. You can see in the image below how CNOOC's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Given the industry it operates in, CNOOC could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CNOOC.
How CNOOC's Current Liabilities Impact Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
CNOOC has total liabilities of CN¥70b and total assets of CN¥679b. As a result, its current liabilities are equal to approximately 10% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On CNOOC's ROCE
With that in mind, CNOOC's ROCE appears pretty good. There might be better investments than CNOOC out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.