Today we'll evaluate Yangarra Resources Ltd. (TSE:YGR) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to 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.
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. In brief, it is a useful tool, but it is not without drawbacks. 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 Yangarra Resources:
0.12 = CA$62m ÷ (CA$566m - CA$57m) (Based on the trailing twelve months to March 2019.)
So, Yangarra Resources has an ROCE of 12%.
Does Yangarra Resources Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Yangarra Resources's ROCE is meaningfully better than the 5.4% average in the Oil and Gas industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Yangarra Resources compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Yangarra Resources has an ROCE of 12%, 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 click on the image below to see (in greater detail) how Yangarra Resources's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Yangarra Resources are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Yangarra Resources.
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 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.
Yangarra Resources has total liabilities of CA$57m and total assets of CA$566m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Yangarra Resources's ROCE
With that in mind, Yangarra Resources's ROCE appears pretty good. Yangarra Resources looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Yangarra Resources better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.