Today we are going to look at Gran Tierra Energy Inc. (NYSEMKT:GTE) 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.
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.
What is Return On Capital Employed (ROCE)?
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. Overall, it is a valuable metric that has its flaws. 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'.
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 Gran Tierra Energy:
0.087 = US$161m ÷ (US$2.0b - US$189m) (Based on the trailing twelve months to June 2019.)
So, Gran Tierra Energy has an ROCE of 8.7%.
Does Gran Tierra Energy Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Gran Tierra Energy's ROCE appears to be around the 8.4% average of the Oil and Gas industry. Separate from how Gran Tierra Energy stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Gran Tierra Energy delivered an ROCE of 8.7%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can click on the image below to see (in greater detail) how Gran Tierra 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. 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, after all, simply a snap shot of a single year. Given the industry it operates in, Gran Tierra Energy could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Gran Tierra Energy.
What Are Current Liabilities, And How Do They Affect Gran Tierra Energy's 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.
Gran Tierra Energy has total liabilities of US$189m and total assets of US$2.0b. Therefore its current liabilities are equivalent to approximately 9.3% of its total assets. Gran Tierra Energy has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From Gran Tierra Energy's ROCE
Based on this information, Gran Tierra Energy appears to be a mediocre business. Of course, you might also be able to find a better stock than Gran Tierra Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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.