Today we are going to look at Woodside Petroleum Ltd (ASX:WPL) 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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?
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 Woodside Petroleum:
0.067 = US$1.9b ÷ (US$29b - US$1.0b) (Based on the trailing twelve months to June 2019.)
Therefore, Woodside Petroleum has an ROCE of 6.7%.
Does Woodside Petroleum Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Woodside Petroleum's ROCE is meaningfully below the Oil and Gas industry average of 13%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Woodside Petroleum'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.
Woodside Petroleum has an ROCE of 6.7%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can see in the image below how Woodside Petroleum's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Woodside Petroleum are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Woodside Petroleum.
Do Woodside Petroleum's Current Liabilities Skew Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Woodside Petroleum has total liabilities of US$1.0b and total assets of US$29b. Therefore its current liabilities are equivalent to approximately 3.6% of its total assets. Woodside Petroleum reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
Our Take On Woodside Petroleum's ROCE
Woodside Petroleum looks like an ok business, but on this analysis it is not at the top of our buy list. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
Woodside Petroleum is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. Thank you for reading.