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What Can We Make Of Orca Exploration Group Inc.’s (CVE:ORC.B) High Return On Capital?

Today we are going to look at Orca Exploration Group Inc. (CVE:ORC.B) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

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.

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 Orca Exploration Group:

0.18 = US$35m ÷ (US$268m - US$69m) (Based on the trailing twelve months to September 2019.)

So, Orca Exploration Group has an ROCE of 18%.

View our latest analysis for Orca Exploration Group

Does Orca Exploration Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Orca Exploration Group'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. Separate from Orca Exploration Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

The image below shows how Orca Exploration Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSXV:ORC.B Past Revenue and Net Income, February 25th 2020
TSXV:ORC.B Past Revenue and Net Income, February 25th 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Orca Exploration Group could be considered a cyclical business. If Orca Exploration Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Orca Exploration Group's Current Liabilities Skew Its 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 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.

Orca Exploration Group has current liabilities of US$69m and total assets of US$268m. As a result, its current liabilities are equal to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On Orca Exploration Group's ROCE

Overall, Orca Exploration Group has a decent ROCE and could be worthy of further research. Orca Exploration Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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 editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.