Today we’ll look at Consolidated Water Co. Ltd. (NASDAQ:CWCO) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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. 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 Consolidated Water:
0.053 = US$9.1m ÷ (US$181m – US$8.3m) (Based on the trailing twelve months to March 2019.)
Therefore, Consolidated Water has an ROCE of 5.3%.
Does Consolidated Water Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Consolidated Water’s ROCE is around the 4.9% average reported by the Water Utilities industry. Putting aside Consolidated Water’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Consolidated Water.
How Consolidated Water’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Consolidated Water has total liabilities of US$8.3m and total assets of US$181m. Therefore its current liabilities are equivalent to approximately 4.6% of its total assets. Consolidated Water has very few current liabilities, which have a minimal effect on its already low ROCE.
The Bottom Line On Consolidated Water’s ROCE
Still, investors could probably find more attractive prospects with better performance out there. Of course, you might also be able to find a better stock than Consolidated Water. So you may wish to see this free collection of other companies that have grown earnings strongly.
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