Today we are going to look at The Williams Companies, Inc. (NYSE:WMB) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Williams Companies:
0.049 = US$2.1b ÷ (US$47b - US$3.4b) (Based on the trailing twelve months to June 2019.)
So, Williams Companies has an ROCE of 4.9%.
Is Williams Companies's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Williams Companies's ROCE appears meaningfully below the 7.5% average reported by the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Williams Companies stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
We can see that , Williams Companies currently has an ROCE of 4.9% compared to its ROCE 3 years ago, which was 3.3%. This makes us think the business might be improving. The image below shows how Williams Companies's ROCE compares to its industry, and you can click it to see more detail on its 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. ROCE is only a point-in-time measure. We note Williams Companies 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 Williams Companies.
Do Williams Companies's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Williams Companies has total liabilities of US$3.4b and total assets of US$47b. Therefore its current liabilities are equivalent to approximately 7.3% of its total assets. With barely any current liabilities, there is minimal impact on Williams Companies's admittedly low ROCE.
What We Can Learn From Williams Companies's ROCE
Still, investors could probably find more attractive prospects with better performance out there. Of course, you might also be able to find a better stock than Williams Companies. 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).
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.