This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in innogy SE (FRA:IGY).
If you purchase a IGY share you are effectively becoming a partner with many other shareholders. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. To understand innogy’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
innogy’s Return On Capital Employed
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if innogy is good at growing investor capital. IGY’s ROCE is calculated below:
ROCE Calculation for IGY
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = €2.57b ÷ (€48.59b – €14.45b) = 7.54%
The calculation above shows that IGY’s earnings were 7.54% of capital employed. A good ROCE hurdle you should aim for in your investments is 15%, which IGY has failed to reach, meaning the company creates an unimpressive amount of earnings from capital employed.
Then why have investors invested?
innogy’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment innogy is in an adverse position, but this can change if these factors improve. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking three years in the past, it is evident that IGY’s ROCE has risen from 5.59%, indicating the company’s capital returns have stengthened. Over the same period, EBT went from €2.17b to €2.57b and the amount of capital employed has decreased as a result of a fall in total assets , which means the company has been able to improve ROCE by growing earnings and simultaneously putting less capital to work.
Despite IGY’s current ROCE remains at an unattractive level, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation to determine if an opportunity exists that isn’t made apparent by looking at past data. innogy’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for IGY’s future growth? Take a look at our free research report of analyst consensus for IGY’s outlook.
- Valuation: What is IGY worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether IGY is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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 firstname.lastname@example.org.