Today we’ll look at Marathon Oil Corporation (NYSE:MRO) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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’.
So, How Do We Calculate ROCE?
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 Marathon Oil:
0.027 = US$502m ÷ (US$20b – US$1.7b) (Based on the trailing twelve months to December 2019.)
Therefore, Marathon Oil has an ROCE of 2.7%.
Does Marathon Oil Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Marathon Oil’s ROCE is meaningfully below the Oil and Gas industry average of 6.8%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Marathon Oil compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. There are potentially more appealing investments elsewhere.
Marathon Oil reported an ROCE of 2.7% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Marathon Oil’s past growth compares to other companies.
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, Marathon Oil could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Marathon Oil.
Do Marathon Oil’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Marathon Oil has total assets of US$20b and current liabilities of US$1.7b. Therefore its current liabilities are equivalent to approximately 8.6% of its total assets. With barely any current liabilities, there is minimal impact on Marathon Oil’s admittedly low ROCE.
The Bottom Line On Marathon Oil’s ROCE
Nevertheless, there are potentially more attractive companies to invest in. Of course, you might also be able to find a better stock than Marathon Oil. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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