Today we are going to look at TOTAL S.A. (EPA:FP) to see whether it might be an attractive investment prospect. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 TOTAL:
0.088 = US$18b ÷ (US$268b - US$66b) (Based on the trailing twelve months to June 2019.)
So, TOTAL has an ROCE of 8.8%.
Is TOTAL's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, TOTAL's ROCE is meaningfully higher than the 5.7% 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 where TOTAL sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that , TOTAL currently has an ROCE of 8.8% compared to its ROCE 3 years ago, which was 3.8%. This makes us wonder if the company is improving. You can see in the image below how TOTAL's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note TOTAL could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for TOTAL.
What Are Current Liabilities, And How Do They Affect TOTAL's 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 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.
TOTAL has total assets of US$268b and current liabilities of US$66b. As a result, its current liabilities are equal to approximately 25% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From TOTAL's ROCE
With that in mind, TOTAL's ROCE appears pretty good. TOTAL shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like TOTAL 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.