Today we are going to look at Rosehill Resources Inc. (NASDAQ:ROSE) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Rosehill Resources:
0.28 = US$225m ÷ (US$866m - US$69m) (Based on the trailing twelve months to September 2019.)
Therefore, Rosehill Resources has an ROCE of 28%.
Is Rosehill Resources's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Rosehill Resources's ROCE appears to be substantially greater than the 8.5% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Rosehill Resources's ROCE currently appears to be excellent.
Rosehill Resources has an ROCE of 28%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how Rosehill Resources's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. Given the industry it operates in, Rosehill 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 Rosehill Resources.
Do Rosehill Resources's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Rosehill Resources has total liabilities of US$69m and total assets of US$866m. As a result, its current liabilities are equal to approximately 7.9% of its total assets. Minimal current liabilities are not distorting Rosehill Resources's impressive ROCE.
What We Can Learn From Rosehill Resources's ROCE
This should mark the company as worthy of further investigation. Rosehill Resources looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.