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Today we are going to look at Corridor Resources Inc. (TSE:CDH) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
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 Corridor Resources:
0.045 = CA$5.7m ÷ (CA$127m - CA$790k) (Based on the trailing twelve months to June 2019.)
So, Corridor Resources has an ROCE of 4.5%.
Is Corridor Resources's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Corridor Resources's ROCE appears to be around the 5.6% average of the Oil and Gas industry. Regardless of how Corridor Resources stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Corridor Resources reported an ROCE of 4.5% -- 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 Corridor Resources's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Corridor Resources could be considered cyclical. How cyclical is Corridor Resources? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Corridor Resources'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Corridor Resources has total assets of CA$127m and current liabilities of CA$790k. Therefore its current liabilities are equivalent to approximately 0.6% of its total assets. Corridor Resources has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On Corridor Resources's ROCE
Nevertheless, there are potentially more attractive companies to invest in. 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.