Today we'll evaluate Ovintiv Inc. (TSE:OVV) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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. 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 Ovintiv:
0.038 = US$729m ÷ (US$21b - US$2.4b) (Based on the trailing twelve months to December 2019.)
So, Ovintiv has an ROCE of 3.8%.
Does Ovintiv Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Ovintiv's ROCE appears to be significantly below the 5.7% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Ovintiv stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Ovintiv has an ROCE of 3.8%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. The image below shows how Ovintiv's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. We note Ovintiv could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ovintiv.
Ovintiv'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Ovintiv has total assets of US$21b and current liabilities of US$2.4b. As a result, its current liabilities are equal to approximately 11% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On Ovintiv's ROCE
Ovintiv has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.
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.
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