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Galp Energia, SGPS, S.A. (ELI:GALP) Earns A Nice Return On Capital Employed

Simply Wall St

Today we are going to look at Galp Energia, SGPS, S.A. (ELI:GALP) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared 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 amount of pre-tax profits a company can generate from the 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?

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 Galp Energia SGPS:

0.12 = €1.3b ÷ (€14b - €3.4b) (Based on the trailing twelve months to September 2019.)

Therefore, Galp Energia SGPS has an ROCE of 12%.

See our latest analysis for Galp Energia SGPS

Does Galp Energia SGPS Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Galp Energia SGPS's ROCE is meaningfully better than the 9.4% 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. Regardless of where Galp Energia SGPS sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Galp Energia SGPS currently has an ROCE of 12%, compared to its ROCE of 4.7% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Galp Energia SGPS's ROCE compares to its industry. Click to see more on past growth.

ENXTLS:GALP Past Revenue and Net Income, January 21st 2020

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. We note Galp Energia SGPS could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Galp Energia SGPS.

What Are Current Liabilities, And How Do They Affect Galp Energia SGPS's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Galp Energia SGPS has total assets of €14b and current liabilities of €3.4b. As a result, its current liabilities are equal to approximately 24% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

The Bottom Line On Galp Energia SGPS's ROCE

Overall, Galp Energia SGPS has a decent ROCE and could be worthy of further research. Galp Energia SGPS 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.

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

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.

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. Thank you for reading.