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Why We Like ShaMaran Petroleum Corp’s (CVE:SNM) 7.2% Return On Capital Employed

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Today we are going to look at ShaMaran Petroleum Corp (CVE:SNM) to see whether it might be an attractive investment prospect. 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?

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 ShaMaran Petroleum:

0.072 = -US$872.0k ÷ (US$421m – US$9.6m) (Based on the trailing twelve months to September 2018.)

So, ShaMaran Petroleum has an ROCE of 7.2%.

See our latest analysis for ShaMaran Petroleum

Is ShaMaran Petroleum’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that ShaMaran Petroleum’s ROCE is meaningfully better than the 5.0% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the industry comparison for now, ShaMaran Petroleum’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.

ShaMaran Petroleum reported an ROCE of 7.2% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving.

TSXV:SNM Last Perf February 12th 19
TSXV:SNM Last Perf February 12th 19

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. ROCE is only a point-in-time measure. We note ShaMaran Petroleum could be considered a cyclical business. 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 ShaMaran Petroleum’s 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

ShaMaran Petroleum has total assets of US$421m and current liabilities of US$9.6m. Therefore its current liabilities are equivalent to approximately 2.3% of its total assets. With low levels of current liabilities, at least ShaMaran Petroleum’s mediocre ROCE is not unduly boosted.

Our Take On ShaMaran Petroleum’s ROCE

If performance improves, then ShaMaran Petroleum may be an OK investment, especially at the right valuation. But note: ShaMaran Petroleum may not be the best stock to buy. 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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.