Yahoo Finance Why You Should Care About SM Energy Company’s (NYSE:SM) Low Return On Capital
Today we'll evaluate SM Energy Company (NYSE:SM) to determine whether it could have potential as an investment idea. 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. Next, we'll compare it to others in its industry. 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. 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 SM Energy:
0.04 = US$238m ÷ (US$6.4b - US$504m) (Based on the trailing twelve months to June 2019.)
Therefore, SM Energy has an ROCE of 4.0%.
View our latest analysis for SM Energy
Does SM Energy Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, SM Energy's ROCE appears to be significantly below the 8.3% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside SM Energy's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
SM Energy reported an ROCE of 4.0% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. The image below shows how SM Energy's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note SM Energy could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for SM Energy.
Do SM Energy's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
SM Energy has total liabilities of US$504m and total assets of US$6.4b. As a result, its current liabilities are equal to approximately 7.9% of its total assets. SM Energy has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From SM Energy's ROCE
Nevertheless, there are potentially more attractive companies to invest in. 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 editorial-team@simplywallst.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.
