Today we are going to look at ONEOK, Inc. (NYSE:OKE) to see whether it might be an attractive investment prospect. 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.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 ONEOK:
0.11 = US$1.9b ÷ (US$20b - US$1.7b) (Based on the trailing twelve months to June 2019.)
Therefore, ONEOK has an ROCE of 11%.
Is ONEOK's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, ONEOK's ROCE is meaningfully higher than the 8.2% 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. Setting aside the industry comparison for now, ONEOK's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
You can click on the image below to see (in greater detail) how ONEOK's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. We note ONEOK could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for ONEOK.
Do ONEOK's Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
ONEOK has total assets of US$20b and current liabilities of US$1.7b. As a result, its current liabilities are equal to approximately 8.8% of its total assets. ONEOK has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
The Bottom Line On ONEOK's ROCE
If performance improves, then ONEOK may be an OK investment, especially at the right valuation. Of course, you might also be able to find a better stock than ONEOK. 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 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.