Today we'll look at Suncor Energy Inc. (TSE:SU) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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'.
How Do You Calculate Return On Capital Employed?
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 Suncor Energy:
0.073 = CA$6.1b ÷ (CA$93b - CA$10b) (Based on the trailing twelve months to September 2019.)
So, Suncor Energy has an ROCE of 7.3%.
Is Suncor Energy's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Suncor Energy's ROCE appears to be substantially greater than the 5.6% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the industry comparison for now, Suncor Energy's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Suncor Energy reported an ROCE of 7.3% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how Suncor Energy's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, Suncor Energy could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Suncor Energy.
Suncor Energy's Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Suncor Energy has total liabilities of CA$10b and total assets of CA$93b. As a result, its current liabilities are equal to approximately 11% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Suncor Energy's ROCE
With that in mind, we're not overly impressed with Suncor Energy's ROCE, so it may not be the most appealing prospect. 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).
There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.
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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. Thank you for reading.