Today we’ll look at Acciona, S.A. (BME:ANA) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. In brief, ROCE is a useful tool, but it is not without drawbacks. 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?
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 Acciona:
0.054 = €598m ÷ (€16b – €5.3b) (Based on the trailing twelve months to September 2018.)
So, Acciona has an ROCE of 5.4%.
Check out our latest analysis for Acciona
Is Acciona’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Acciona’s ROCE appears to be significantly below the 7.2% average in the Electric Utilities industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Acciona stacks up against its industry, its ROCE in absolute terms is mediocre; not much better than the returns on government bonds. It is possible that there are more rewarding investments out there.
When considering this metric, keep in mind that it is backwards looking, and 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. You can see analyst predictions in our free report on analyst forecasts for the company.
Do Acciona’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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) unfairly boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Acciona has total liabilities of €5.3b and total assets of €16b. As a result, its current liabilities are equal to approximately 33% of its total assets. Acciona has a medium level of current liabilities, which would boost its ROCE somewhat.
The Bottom Line On Acciona’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. A good or bad ROCE tells us something about a business, but we need to do more research before making a purchase. One data point to check is if insiders have bought shares recently.
Of course Acciona may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.