Today we'll evaluate Golden Energy and Resources Limited (SGX:AUE) to determine whether it could have potential as an investment idea. 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Golden Energy and Resources:
0.09 = US$74m ÷ (US$1.1b - US$296m) (Based on the trailing twelve months to September 2019.)
Therefore, Golden Energy and Resources has an ROCE of 9.0%.
Does Golden Energy and Resources Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Golden Energy and Resources's ROCE is around the 8.9% average reported by the Oil and Gas industry. Aside from the industry comparison, Golden Energy and Resources's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
We can see that, Golden Energy and Resources currently has an ROCE of 9.0% compared to its ROCE 3 years ago, which was 5.2%. This makes us think the business might be improving. The image below shows how Golden Energy and Resources's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. Remember that most companies like Golden Energy and Resources are cyclical businesses. You can check if Golden Energy and Resources has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Golden Energy and Resources's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Golden Energy and Resources has total assets of US$1.1b and current liabilities of US$296m. As a result, its current liabilities are equal to approximately 26% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Golden Energy and Resources's ROCE
That said, Golden Energy and Resources's ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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