Today we are going to look at EOG Resources, Inc. (NYSE:EOG) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 EOG Resources:
0.14 = US$4.5b ÷ (US$36b - US$4.4b) (Based on the trailing twelve months to June 2019.)
Therefore, EOG Resources has an ROCE of 14%.
Is EOG Resources's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, EOG Resources's ROCE is meaningfully higher than the 8.3% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how EOG Resources compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
EOG Resources has an ROCE of 14%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. The image below shows how EOG Resources's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. Given the industry it operates in, EOG Resources could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do EOG Resources'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
EOG Resources has total assets of US$36b and current liabilities of US$4.4b. As a result, its current liabilities are equal to approximately 12% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From EOG Resources's ROCE
Overall, EOG Resources has a decent ROCE and could be worthy of further research. EOG Resources shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 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.