What Can We Make Of Cabot Oil & Gas Corporation’s (NYSE:COG) High Return On Capital?

Simply Wall St

Today we are going to look at Cabot Oil & Gas Corporation (NYSE:COG) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

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

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?

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 Cabot Oil & Gas:

0.25 = US$1.1b ÷ (US$4.6b - US$234m) (Based on the trailing twelve months to June 2019.)

So, Cabot Oil & Gas has an ROCE of 25%.

See our latest analysis for Cabot Oil & Gas

Does Cabot Oil & Gas Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, Cabot Oil & Gas's ROCE is meaningfully higher than the 8.3% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Cabot Oil & Gas's ROCE is currently very good.

Cabot Oil & Gas has an ROCE of 25%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can see in the image below how Cabot Oil & Gas's ROCE compares to its industry. Click to see more on past growth.

NYSE:COG Past Revenue and Net Income, October 22nd 2019
NYSE:COG Past Revenue and Net Income, October 22nd 2019

It is important to remember that ROCE shows past performance, and is 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. Remember that most companies like Cabot Oil & Gas are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Cabot Oil & Gas.

How Cabot Oil & Gas's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Cabot Oil & Gas has total liabilities of US$234m and total assets of US$4.6b. As a result, its current liabilities are equal to approximately 5.1% of its total assets. Minimal current liabilities are not distorting Cabot Oil & Gas's impressive ROCE.

The Bottom Line On Cabot Oil & Gas's ROCE

This should mark the company as worthy of further investigation. There might be better investments than Cabot Oil & Gas out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

Cabot Oil & Gas is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.