Yahoo Finance Is Santos Limited’s (ASX:STO) Return On Capital Employed Any Good?
Today we'll look at Santos Limited (ASX:STO) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Santos:
0.075 = US$1.1b ÷ (US$17b - US$1.3b) (Based on the trailing twelve months to December 2019.)
So, Santos has an ROCE of 7.5%.
View our latest analysis for Santos
Does Santos Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Santos's ROCE is fairly close to the Oil and Gas industry average of 7.4%. Setting aside the industry comparison for now, Santos'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.
Santos has an ROCE of 7.5%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how Santos's ROCE compares to its industry. Click to see more on 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, after all, simply a snap shot of a single year. Remember that most companies like Santos are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Santos.
How Santos's Current Liabilities Impact 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Santos has current liabilities of US$1.3b and total assets of US$17b. As a result, its current liabilities are equal to approximately 8.0% of its total assets. With low levels of current liabilities, at least Santos's mediocre ROCE is not unduly boosted.
Our Take On Santos's ROCE
Based on this information, Santos appears to be a mediocre business. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.
