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Today we’ll evaluate Carrizo Oil & Gas, Inc. (NASDAQ:CRZO) 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Carrizo Oil & Gas:
0.091 = US$178m ÷ (US$2.9b – US$556m) (Based on the trailing twelve months to September 2018.)
Therefore, Carrizo Oil & Gas has an ROCE of 9.1%.
Does Carrizo Oil & Gas Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Carrizo Oil & Gas’s ROCE is meaningfully better than the 6.6% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how Carrizo Oil & Gas stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
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. Given the industry it operates in, Carrizo Oil & Gas could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Carrizo Oil & Gas.
Carrizo Oil & Gas’s Current Liabilities And Their Impact On Its 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Carrizo Oil & Gas has total assets of US$2.9b and current liabilities of US$556m. As a result, its current liabilities are equal to approximately 19% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Carrizo Oil & Gas’s ROCE
That said, Carrizo Oil & Gas’s ROCE is mediocre, there may be more attractive investments around. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.