Today we are going to look at Concho Resources Inc. (NYSE:CXO) 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Concho Resources:
0.087 = US$2.2b ÷ (US$26b - US$1.4b) (Based on the trailing twelve months to December 2018.)
So, Concho Resources has an ROCE of 8.7%.
Does Concho Resources Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Concho Resources's ROCE appears to be around the 9.2% average of the Oil and Gas industry. Separate from how Concho Resources 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.
As we can see, Concho Resources currently has an ROCE of 8.7% compared to its ROCE 3 years ago, which was 3.0%. This makes us think about whether the company has been reinvesting shrewdly.
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, Concho Resources 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 Concho Resources.
How Concho Resources's Current Liabilities Impact Its 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Concho Resources has total assets of US$26b and current liabilities of US$1.4b. Therefore its current liabilities are equivalent to approximately 5.2% of its total assets. Concho Resources has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On Concho Resources's ROCE
Concho Resources looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Concho Resources. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 email@example.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. Thank you for reading.