Today we’ll evaluate W&T Offshore, Inc. (NYSE:WTI) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
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.
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. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for W&T Offshore:
0.27 = US$110m ÷ (US$1.1b – US$447m) (Based on the trailing twelve months to September 2018.)
Therefore, W&T Offshore has an ROCE of 27%.
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Is W&T Offshore’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, W&T Offshore’s ROCE is meaningfully higher than the 5.6% 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, W&T Offshore’s ROCE currently appears to be excellent.
W&T Offshore reported an ROCE of 27% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like W&T Offshore are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for W&T Offshore.
How W&T Offshore’s Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
W&T Offshore has total assets of US$1.1b and current liabilities of US$447m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. A medium level of current liabilities boosts W&T Offshore’s ROCE somewhat.
The Bottom Line On W&T Offshore’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. But note: W&T Offshore may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like W&T Offshore better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.