Today we'll evaluate Crown Point Energy Inc. (CVE:CWV) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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 Crown Point Energy:
0.26 = US$17m ÷ (US$77m - US$14m) (Based on the trailing twelve months to June 2019.)
So, Crown Point Energy has an ROCE of 26%.
Does Crown Point Energy Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Crown Point Energy's ROCE is meaningfully better than the 5.6% 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 comparison to its industry for a moment, Crown Point Energy's ROCE in absolute terms currently looks quite high.
Crown Point Energy reported an ROCE of 26% -- 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 Crown Point Energy's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. We note Crown Point Energy could be considered a cyclical business. If Crown Point Energy is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Crown Point Energy's Current Liabilities Skew 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Crown Point Energy has total liabilities of US$14m and total assets of US$77m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From Crown Point Energy's ROCE
With low current liabilities and a high ROCE, Crown Point Energy could be worthy of further investigation. Crown Point Energy looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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.