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Today we are going to look at Cabot Oil & Gas Corporation (NYSE:COG) to see whether it might be an attractive investment prospect. 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.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. In brief, it is a useful tool, but it is not without drawbacks. 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’.
How Do You Calculate Return On Capital Employed?
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 Cabot Oil & Gas:
0.028 = -US$36.0m ÷ (US$4.2b – US$366m) (Based on the trailing twelve months to September 2018.)
So, Cabot Oil & Gas has an ROCE of 2.8%.
Does Cabot Oil & Gas Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Cabot Oil & Gas’s ROCE appears meaningfully below the 6.2% average reported by the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Cabot Oil & Gas’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
Cabot Oil & Gas’s current ROCE of 2.8% is lower than 3 years ago, when the company reported a 6.0% ROCE. This makes us wonder if the business is facing new challenges.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. Remember that most companies like Cabot Oil & Gas are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Cabot Oil & Gas.
Do Cabot Oil & Gas’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Cabot Oil & Gas has total liabilities of US$366m and total assets of US$4.2b. As a result, its current liabilities are equal to approximately 8.8% of its total assets. With barely any current liabilities, there is minimal impact on Cabot Oil & Gas’s admittedly low ROCE.
The Bottom Line On Cabot Oil & Gas’s ROCE
Still, investors could probably find more attractive prospects with better performance out there. But note: Cabot Oil & Gas may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.