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Should Natural Gas Services Group, Inc.’s (NYSE:NGS) Weak Investment Returns Worry You?

Simply Wall St

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Today we are going to look at Natural Gas Services Group, Inc. (NYSE:NGS) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?

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 Natural Gas Services Group:

0.0022 = US$638k ÷ (US$305m - US$11m) (Based on the trailing twelve months to December 2018.)

Therefore, Natural Gas Services Group has an ROCE of 0.2%.

See our latest analysis for Natural Gas Services Group

Does Natural Gas Services Group Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Natural Gas Services Group's ROCE is meaningfully below the Energy Services industry average of 11%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Natural Gas Services Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.

Natural Gas Services Group's current ROCE of 0.2% is lower than 3 years ago, when the company reported a 6.9% ROCE. This makes us wonder if the business is facing new challenges.

NYSE:NGS Past Revenue and Net Income, April 29th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. We note Natural Gas Services Group could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Natural Gas Services Group's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Natural Gas Services Group has total assets of US$305m and current liabilities of US$11m. Therefore its current liabilities are equivalent to approximately 3.6% of its total assets. Natural Gas Services Group has a low level of current liabilities, which have a negligible impact on its already low ROCE.

Our Take On Natural Gas Services Group's ROCE

Nevertheless, there are potentially more attractive companies to invest in. Of course, you might also be able to find a better stock than Natural Gas Services Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Natural Gas Services Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 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. Thank you for reading.