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Today we'll evaluate TGS-NOPEC Geophysical Company ASA (OB:TGS) 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 TGS-NOPEC Geophysical:
0.19 = US$242m ÷ (US$1.6b - US$314m) (Based on the trailing twelve months to March 2019.)
Therefore, TGS-NOPEC Geophysical has an ROCE of 19%.
Does TGS-NOPEC Geophysical Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. TGS-NOPEC Geophysical's ROCE appears to be substantially greater than the 7.4% average in the Energy Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how TGS-NOPEC Geophysical compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , TGS-NOPEC Geophysical currently has an ROCE of 19% compared to its ROCE 3 years ago, which was 8.0%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how TGS-NOPEC Geophysical'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Remember that most companies like TGS-NOPEC Geophysical are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for TGS-NOPEC Geophysical.
How TGS-NOPEC Geophysical's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
TGS-NOPEC Geophysical has total assets of US$1.6b and current liabilities of US$314m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On TGS-NOPEC Geophysical's ROCE
With that in mind, TGS-NOPEC Geophysical's ROCE appears pretty good. There might be better investments than TGS-NOPEC Geophysical 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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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 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.