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Today we are going to look at Callon Petroleum Company (NYSE:CPE) to see whether it might be an attractive investment prospect.
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.
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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business.
All else being equal, a better business will have a higher ROCE.
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’.
So, How Do We Calculate ROCE?
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 Callon Petroleum:
0.051 = US$126m ÷ (US$3.7b – US$333m) (Based on the trailing twelve months to September 2018.)
Therefore, Callon Petroleum has an ROCE of 5.1%.
Does Callon Petroleum Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful.
It appears that Callon Petroleum’s ROCE is fairly close to the Oil and Gas industry average of 6.1%.
Independently of how Callon Petroleum compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds.
There are potentially more appealing investments elsewhere.
Callon Petroleum’s current ROCE of 5.1% is lower than 3 years ago, when the company reported a 7.8% ROCE.
So investors might consider if it has had issues recently.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future.
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.
Remember that most companies like Callon Petroleum are cyclical businesses.
Since the future is so important for investors, you should check out our free report on analyst forecasts for Callon Petroleum.
Do Callon Petroleum’s Current Liabilities Skew 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.
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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Callon Petroleum has total liabilities of US$333m and total assets of US$3.7b.
As a result, its current liabilities are equal to approximately 9.0% of its total assets.
Callon Petroleum has a low level of current liabilities, which have a negligible impact on its already low ROCE.
The Bottom Line On Callon Petroleum’s ROCE
Still, investors could probably find more attractive prospects with better performance out there.
You might be able to find a better buy than Callon Petroleum. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.
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