Today we'll evaluate Orca Exploration Group Inc. (CVE:ORC.B) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is 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. 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 Orca Exploration Group:
0.15 = US$31m ÷ (US$271m - US$62m) (Based on the trailing twelve months to June 2019.)
Therefore, Orca Exploration Group has an ROCE of 15%.
Does Orca Exploration Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Orca Exploration Group's ROCE is meaningfully higher than the 5.8% 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 Orca Exploration Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Orca Exploration Group's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Orca Exploration Group are cyclical businesses. You can check if Orca Exploration Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Orca Exploration Group'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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Orca Exploration Group has total liabilities of US$62m and total assets of US$271m. As a result, its current liabilities are equal to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Orca Exploration Group's ROCE
With that in mind, Orca Exploration Group's ROCE appears pretty good. There might be better investments than Orca Exploration Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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 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.