Today we'll evaluate Cobra Venture Corporation (CVE:CBV) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?
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 Cobra Venture:
0.017 = CA$59k ÷ (CA$3.5m - CA$38k) (Based on the trailing twelve months to November 2019.)
So, Cobra Venture has an ROCE of 1.7%.
Does Cobra Venture Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Cobra Venture's ROCE appears meaningfully below the 5.5% average reported by the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Cobra Venture compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.4% available in government bonds. There are potentially more appealing investments elsewhere.
Cobra Venture delivered an ROCE of 1.7%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can see in the image below how Cobra Venture's ROCE compares to its industry. Click to see more on past growth.
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. Given the industry it operates in, Cobra Venture could be considered cyclical. How cyclical is Cobra Venture? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Cobra Venture's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cobra Venture has current liabilities of CA$38k and total assets of CA$3.5m. As a result, its current liabilities are equal to approximately 1.1% of its total assets. Cobra Venture has very few current liabilities, which have a minimal effect on its already low ROCE.
The Bottom Line On Cobra Venture's ROCE
Still, investors could probably find more attractive prospects with better performance out there. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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. Thank you for reading.