• 3 minutes China has *Already* Lost the Trade War. Meantime, the U.S. Might Sanction China’s Largest Oil Company
  • 7 minutes Saudi and UAE pressure to get US support for Oil quotas is reportedly on..
  • 11 minutes China devalues currency to lower prices to address new tariffs. But doesn't help. Here is why. . . .
  • 15 minutes What is your current outlook as a day trader for WTI
  • 3 hours Domino Effect: Rashida Tlaib Rejects Israel's Offer For 'Humanitarian' Visit To West Bank
  • 15 hours Will Uncle Sam Step Up and Cut Production
  • 3 mins In The Bright Of New Administration Rules: Immigrants as Economic Contributors
  • 2 days Movie Script: Epstein Guards Suspected Of Falsifying Logs
  • 16 hours Trump vs. Xi Trade Battle, Running Commentary from Conservative Tree House
  • 3 hours Continental Resource's Hamm (Trump Buddy) wants shale to cut production.Can't compete with peers. Stock will drop in half again.
  • 4 hours Gretta Thunbergs zero carbon voyage carbon foot print of carbon fibre manufacture
  • 1 day Significant: Boeing Delays Delivery Of Ultra-Long-Range Version Of 777X
  • 12 hours NATGAS, LNG, Technology, benefits etc , cleaner global energy fuel
  • 2 days I think I might be wrong about a 2020 shakeout
  • 2 days Kremlin Says WTO's Existence Would Be In Doubt If the U.S., Others Left
  • 2 days Why Oil is Falling (including conspiracy theories and other fun stuff)
  • 52 days To be(lieve) or Not To be(lieve): U.S. Treasury Secretary Says U.S.-China Trade Deal Is 90% Done
Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

More Info

Premium Content

The Newest Metric For Gauging Stock Performance In The Oil Patch

Investors pondering their choices as oil prices continue to recover must attempt to determine which firms are the best investments. The problem is that every company management team is trying to put the best spin on their results in quarterly conference calls and investor presentations. As a result, sage investors should take a careful look at more objective measures of value and success in firms. One of the best metrics for doing that is Return on Invested Capital or ROIC.

ROIC has recently become a much more popular metric on Wall Street, and that’s good for investors. ROIC can be complex to calculate, but essentially it is just a measure of how efficient a company is with respect to its capital. The formula divides cash flow by a company’s equity and debt less its cash balance. Firms which earn high margins and use their assets effectively are rewarding investors and earning a high ROIC. Such efficiency has been rare among many oil companies, which spent years wasting capital drilling wells with questionable long run economics. Related: Oil Slips After EIA Reports 1.3M Barrel Build

Using ROIC as an investing metric can be lucrative for investors. Stocks in the highest quintile of ROIC over the last 12 years had an average stock price return of 10.5 percent annually while firms in the lowest quintile had an average stock price return of 8.1 percent.

Oil companies looking to enhance ROIC can pursue a number of strategies to boost their results. One option is to use asset-backed trading efforts to reduce capital needs based on asset allocation. In particular, firms can benefit from either prudent use of arbitrage strategies related to crude quality, location, storage opportunities, etc. These can result in an attractive risk-free return for smart companies. Related: Are The Saudis Facing A Full-Blown Liquidity Crisis?

Similarly, oil companies can also reduce their required assets through off balance sheet transactions that give them low cost sources of funding such as off-balance sheet greenfield investments with retained usage rights through tolling. These types of transactions give firms effective control over an asset’s capacity without tying up full capital funding. These types of transactions, along with various working capital related financial structures, can reduce capital employed by as much as 20 percent in some instances. While capital light balance sheet structures do require robust enterprise risk management methods, they are an effective tool in boosting returns.

Finally, firms can increase their margins through effective joint ventures and M&A deals that help sustain reserve-replacement ratios. These deals are particularly attractive at present given the current state of the industry. Value engineering and capital optimization techniques make these deals potentially even more attractive. Related: Wildfire Nears Canada’s Major Oil Sands Plants

All three methods of boosting ROIC can enhance the attractiveness of a firm to investors and lenders. Given present industry circumstances, lenders are only interested in working with the most stable and efficient firms. ROIC is a useful metric to demonstrate that stability.

The point here is that ROIC is a metric that both firms and investors should care about. The levers to pull on ROIC are not as simple as the manipulation that can be done with EPS, but they are worthwhile endeavors that can help firms to run more efficiently and boost returns for shareholders as well.

By Michael McDonald of Oilprice.com

More Top Reads From Oilprice.com:




Download The Free Oilprice App Today

Back to homepage


Leave a comment

Leave a comment




Oilprice - The No. 1 Source for Oil & Energy News
Download on the App Store Get it on Google Play