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Today we are going to look at VAALCO Energy, Inc. (NYSE:EGY) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 VAALCO Energy:
0.26 = US$41m ÷ (US$202m - US$43m) (Based on the trailing twelve months to March 2019.)
Therefore, VAALCO Energy has an ROCE of 26%.
Is VAALCO Energy's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, VAALCO Energy's ROCE is meaningfully higher than the 7.4% 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, VAALCO Energy's ROCE currently appears to be excellent.
In our analysis, VAALCO Energy's ROCE appears to be 26%, compared to 3 years ago, when its ROCE was 6.8%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how VAALCO Energy's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, VAALCO Energy could be considered cyclical. If VAALCO Energy is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
VAALCO Energy'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.
VAALCO Energy has total assets of US$202m and current liabilities of US$43m. As a result, its current liabilities are equal to approximately 21% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
Our Take On VAALCO Energy's ROCE
With low current liabilities and a high ROCE, VAALCO Energy could be worthy of further investigation. VAALCO 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.
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.