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Today we are going to look at SFL Corporation Ltd. (NYSE:SFL) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. 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 measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 SFL:
0.055 = US$193m ÷ (US$3.8b - US$273m) (Based on the trailing twelve months to September 2019.)
So, SFL has an ROCE of 5.5%.
Is SFL's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see SFL's ROCE is meaningfully below the Oil and Gas industry average of 8.9%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, SFL's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
You can see in the image below how SFL's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Remember that most companies like SFL are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for SFL.
What Are Current Liabilities, And How Do They Affect SFL's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
SFL has total assets of US$3.8b and current liabilities of US$273m. As a result, its current liabilities are equal to approximately 7.2% of its total assets. SFL reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
The Bottom Line On SFL's ROCE
SFL looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than SFL. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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