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Today we are going to look at Gulf Keystone Petroleum Limited (LON:GKP) 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 of all, we’ll work out how to 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.
What is 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. 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?
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 Gulf Keystone Petroleum:
0.07 = US$23m ÷ (US$708m – US$87m) (Based on the trailing twelve months to June 2018.)
Therefore, Gulf Keystone Petroleum has an ROCE of 7.0%.
See our latest analysis for Gulf Keystone Petroleum
Is Gulf Keystone Petroleum’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Gulf Keystone Petroleum’s ROCE is meaningfully better than the 5.3% 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, Gulf Keystone 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.
Gulf Keystone Petroleum has an ROCE of 7.0%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.
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 only a point-in-time measure. We note Gulf Keystone 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.