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Today we’ll look at Yangarra Resources Ltd. (TSE:YGR) and reflect on its potential as an investment. 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. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from 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’.
So, How Do We Calculate ROCE?
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 Yangarra Resources:
0.093 = CA$30m ÷ (CA$479m – CA$62m) (Based on the trailing twelve months to September 2018.)
So, Yangarra Resources has an ROCE of 9.3%.
Does Yangarra Resources Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Yangarra Resources’s ROCE appears to be substantially greater than the 5.0% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Aside from the industry comparison, Yangarra Resources’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Yangarra Resources could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Yangarra Resources’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Yangarra Resources has total assets of CA$479m and current liabilities of CA$62m. As a result, its current liabilities are equal to approximately 13% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Yangarra Resources’s ROCE
That said, Yangarra Resources’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Yangarra Resources. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.