Is Capital Power Corporation’s (TSE:CPX) 9.1% Return On Capital Employed Good News?

Today we are going to look at Capital Power Corporation (TSE:CPX) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

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

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 Capital Power:

0.091 = CA$651m ÷ (CA$8.6b - CA$1.4b) (Based on the trailing twelve months to December 2019.)

So, Capital Power has an ROCE of 9.1%.

View our latest analysis for Capital Power

Does Capital Power Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Capital Power's ROCE appears to be around the 8.3% average of the Renewable Energy industry. Setting aside the industry comparison for now, Capital Power's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

In our analysis, Capital Power's ROCE appears to be 9.1%, compared to 3 years ago, when its ROCE was 4.8%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Capital Power's past growth compares to other companies.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Capital Power.

How Capital Power's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Capital Power has total assets of CA$8.6b and current liabilities of CA$1.4b. As a result, its current liabilities are equal to approximately 17% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From Capital Power's ROCE

That said, Capital Power's ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.