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Is Continental Resources, Inc.’s (NYSE:CLR) 10% ROCE Any Good?

Simply Wall St

Today we are going to look at Continental Resources, Inc. (NYSE:CLR) 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.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Continental Resources:

0.10 = US$1.5b ÷ (US$16b - US$1.4b) (Based on the trailing twelve months to June 2019.)

Therefore, Continental Resources has an ROCE of 10%.

View our latest analysis for Continental Resources

Does Continental Resources Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Continental Resources's ROCE is meaningfully higher than the 8.4% average in the Oil and Gas industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the industry comparison for now, Continental Resources's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Continental Resources reported an ROCE of 10% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how Continental Resources's past growth compares to other companies.

NYSE:CLR Past Revenue and Net Income, August 26th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Given the industry it operates in, Continental Resources could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Continental Resources.

How Continental Resources's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.

Continental Resources has total assets of US$16b and current liabilities of US$1.4b. As a result, its current liabilities are equal to approximately 8.6% of its total assets. Continental Resources has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

Our Take On Continental Resources's ROCE

Continental Resources looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Continental Resources better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 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. Thank you for reading.