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What Can We Learn From Peyto Exploration & Development Corp.’s (TSE:PEY) Investment Returns?

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Today we'll look at Peyto Exploration & Development Corp. (TSE:PEY) 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.

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.

Return On Capital Employed (ROCE): What is it?

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. 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.'

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Peyto Exploration & Development:

0.056 = CA$200m ÷ (CA$3.7b - CA$77m) (Based on the trailing twelve months to March 2019.)

Therefore, Peyto Exploration & Development has an ROCE of 5.6%.

See our latest analysis for Peyto Exploration & Development

Is Peyto Exploration & Development's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Peyto Exploration & Development's ROCE is around the 5.5% average reported by the Oil and Gas industry. Aside from the industry comparison, Peyto Exploration & Development's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

The image below shows how Peyto Exploration & Development's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:PEY Past Revenue and Net Income, July 12th 2019
TSX:PEY Past Revenue and Net Income, July 12th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Peyto Exploration & Development could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Peyto Exploration & Development's 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Peyto Exploration & Development has total assets of CA$3.7b and current liabilities of CA$77m. Therefore its current liabilities are equivalent to approximately 2.1% of its total assets. Peyto Exploration & Development has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

Our Take On Peyto Exploration & Development's ROCE

If performance improves, then Peyto Exploration & Development may be an OK investment, especially at the right valuation. 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).

I will like Peyto Exploration & Development better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.