Today we are going to look at Goodrich Petroleum Corporation (NYSEMKT:GDP) to see whether it might be an attractive investment prospect. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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.
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$27m ÷ (US$244m - US$43m) (Based on the trailing twelve months to March 2020.)
Therefore, Goodrich Petroleum has an ROCE of 13%.
Is Goodrich Petroleum's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Goodrich Petroleum's ROCE appears to be substantially greater than the 7.7% 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.
Goodrich Petroleum has an ROCE of 13%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can click on the image below to see (in greater detail) how Goodrich Petroleum's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 Goodrich Petroleum are cyclical businesses. 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Goodrich Petroleum has current liabilities of US$43m and total assets of US$244m. As a result, its current liabilities are equal to approximately 17% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Goodrich Petroleum's ROCE
Overall, Goodrich Petroleum has a decent ROCE and could be worthy of further research. 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.
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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.