Today we'll look at TransGlobe Energy Corporation (NASDAQ:TGA) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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'.
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 TransGlobe Energy:
0.11 = US$32m ÷ (US$316m - US$22m) (Based on the trailing twelve months to June 2019.)
So, TransGlobe Energy has an ROCE of 11%.
Does TransGlobe Energy Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that TransGlobe Energy's ROCE is meaningfully better than the 8.3% 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. Regardless of where TransGlobe Energy sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
TransGlobe Energy delivered an ROCE of 11%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how TransGlobe Energy's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, TransGlobe Energy could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect TransGlobe Energy's 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 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.
TransGlobe Energy has total assets of US$316m and current liabilities of US$22m. As a result, its current liabilities are equal to approximately 7.1% of its total assets. With low current liabilities, TransGlobe Energy's decent ROCE looks that much more respectable.
Our Take On TransGlobe Energy's ROCE
If TransGlobe Energy can continue reinvesting in its business, it could be an attractive prospect. TransGlobe Energy 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 firstname.lastname@example.org. 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.