Today we’ll look at Ormat Technologies, Inc. (NYSE:ORA) 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 Ormat Technologies:
0.065 = US$190m ÷ (US$3.2b – US$277m) (Based on the trailing twelve months to June 2019.)
So, Ormat Technologies has an ROCE of 6.5%.
Is Ormat Technologies’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Ormat Technologies’s ROCE is around the 6.5% average reported by the Renewable Energy industry. Setting aside the industry comparison for now, Ormat Technologies’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
We can see that, Ormat Technologies currently has an ROCE of 6.5%, less than the 9.5% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. Take a look at the image below to see how Ormat Technologies’s past growth compares to the average in its industry.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Ormat Technologies.
What Are Current Liabilities, And How Do They Affect Ormat Technologies’s 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 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.
Ormat Technologies has total assets of US$3.2b and current liabilities of US$277m. Therefore its current liabilities are equivalent to approximately 8.7% of its total assets. With low levels of current liabilities, at least Ormat Technologies’s mediocre ROCE is not unduly boosted.
Our Take On Ormat Technologies’s ROCE
Based on this information, Ormat Technologies appears to be a mediocre business. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.