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Today we'll evaluate Ring Energy, Inc. (NYSEMKT:REI) to determine whether it could have potential as an investment idea. 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.
Firstly, we'll go over how we 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Ring Energy:
0.11 = US$108m ÷ (US$1.0b - US$40m) (Based on the trailing twelve months to March 2020.)
So, Ring Energy has an ROCE of 11%.
Is Ring Energy's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Ring Energy's ROCE is meaningfully better than the 7.6% 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. Separate from Ring Energy's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Ring Energy currently has an ROCE of 11%, compared to its ROCE of 1.5% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Ring 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Ring Energy could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ring Energy.
What Are Current Liabilities, And How Do They Affect Ring Energy'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ring Energy has current liabilities of US$40m and total assets of US$1.0b. As a result, its current liabilities are equal to approximately 4.0% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Ring Energy earns a sound return on capital employed.
Our Take On Ring Energy's ROCE
If it is able to keep this up, Ring Energy could be attractive. Ring Energy shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
Ring Energy is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.