Today we are going to look at NRG Energy, Inc. (NYSE:NRG) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
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. 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’.
How Do You Calculate Return On Capital Employed?
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 NRG Energy:
0.15 = US$1.1b ÷ (US$9.2b – US$2.3b) (Based on the trailing twelve months to June 2019.)
So, NRG Energy has an ROCE of 15%.
Is NRG Energy’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. NRG Energy’s ROCE appears to be substantially greater than the 6.5% average in the Renewable Energy industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how NRG Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, NRG Energy currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 4.9%. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for NRG Energy.
What Are Current Liabilities, And How Do They Affect NRG Energy’s 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.
NRG Energy has total liabilities of US$2.3b and total assets of US$9.2b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On NRG Energy’s ROCE
Overall, NRG Energy has a decent ROCE and could be worthy of further research. There might be better investments than NRG Energy 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.
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