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Today we’ll look at Phillips 66 (NYSE:PSX) 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.
First, we’ll go over how we 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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 Phillips 66:
0.11 = US$5.2b ÷ (US$54b – US$8.9b) (Based on the trailing twelve months to December 2018.)
So, Phillips 66 has an ROCE of 11%.
Is Phillips 66’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Phillips 66’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 Phillips 66’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
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 only a point-in-time measure. Given the industry it operates in, Phillips 66 could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Phillips 66.
How Phillips 66’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Phillips 66 has total assets of US$54b and current liabilities of US$8.9b. As a result, its current liabilities are equal to approximately 16% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Phillips 66’s ROCE
Overall, Phillips 66 has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than Phillips 66. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Phillips 66 better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.