Today we’ll look at The Williams Companies, Inc. (NYSE:WMB) 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Williams Companies:
0.043 = US$1.7b ÷ (US$47b – US$2.8b) (Based on the trailing twelve months to September 2018.)
So, Williams Companies has an ROCE of 4.3%.
Does Williams Companies Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Williams Companies’s ROCE appears to be significantly below the 5.6% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Williams Companies stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
In our analysis, Williams Companies’s ROCE appears to be 4.3%, compared to 3 years ago, when its ROCE was 2.8%. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Remember that most companies like Williams Companies are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Williams Companies.
How Williams Companies’s Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Williams Companies has total liabilities of US$2.8b and total assets of US$47b. Therefore its current liabilities are equivalent to approximately 5.9% of its total assets. Williams Companies has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On Williams Companies’s ROCE
Nonetheless, there may be better places to invest your capital. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.