In This Article:
Today we are going to look at Woodside Petroleum Ltd (ASX:WPL) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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.
How Do You Calculate Return On Capital Employed?
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 Woodside Petroleum:
0.067 = US$1.9b ÷ (US$29b - US$1.0b) (Based on the trailing twelve months to June 2019.)
Therefore, Woodside Petroleum has an ROCE of 6.7%.
See our latest analysis for Woodside Petroleum
Does Woodside Petroleum Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Woodside Petroleum's ROCE is meaningfully below the Oil and Gas industry average of 13%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Woodside Petroleum's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Woodside Petroleum has an ROCE of 6.7%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can see in the image below how Woodside Petroleum'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 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. Remember that most companies like Woodside Petroleum are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Woodside Petroleum.