Today we'll look at Eco (Atlantic) Oil & Gas Ltd. (CVE:EOG) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Eco (Atlantic) Oil & Gas:
0.18 = CA$4.6m ÷ (CA$27m - CA$1.6m) (Based on the trailing twelve months to March 2019.)
Therefore, Eco (Atlantic) Oil & Gas has an ROCE of 18%.
Does Eco (Atlantic) Oil & Gas Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Eco (Atlantic) Oil & Gas's ROCE is meaningfully higher than the 5.6% 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 Eco (Atlantic) Oil & Gas sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Eco (Atlantic) Oil & Gas delivered an ROCE of 18%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can see in the image below how Eco (Atlantic) Oil & Gas's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Eco (Atlantic) Oil & Gas are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Eco (Atlantic) Oil & Gas's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Eco (Atlantic) Oil & Gas has total assets of CA$27m and current liabilities of CA$1.6m. As a result, its current liabilities are equal to approximately 5.8% of its total assets. With low current liabilities, Eco (Atlantic) Oil & Gas's decent ROCE looks that much more respectable.
The Bottom Line On Eco (Atlantic) Oil & Gas's ROCE
This is good to see, and while better prospects may exist, Eco (Atlantic) Oil & Gas seems worth researching further. There might be better investments than Eco (Atlantic) Oil & Gas 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.
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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. Thank you for reading.