Yahoo Finance Why We Like Goodrich Petroleum Corporation’s (NYSEMKT:GDP) 13% Return On Capital Employed
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Today we'll evaluate Goodrich Petroleum Corporation (NYSEMKT:GDP) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.
So, How Do We Calculate ROCE?
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 Goodrich Petroleum:
0.13 = US$20m ÷ (US$204m - US$47m) (Based on the trailing twelve months to March 2019.)
So, Goodrich Petroleum has an ROCE of 13%.
See our latest analysis for Goodrich Petroleum
Does Goodrich Petroleum Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Goodrich Petroleum's ROCE is meaningfully higher than the 7.4% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Goodrich Petroleum sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Goodrich Petroleum could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Goodrich Petroleum.
Do Goodrich Petroleum'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Goodrich Petroleum has total assets of US$204m and current liabilities of US$47m. As a result, its current liabilities are equal to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Goodrich Petroleum's ROCE
This is good to see, and with a sound ROCE, Goodrich Petroleum could be worth a closer look. Goodrich Petroleum 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
