Today we’ll look at Biomass Energy Project S.A. (WSE:BEP) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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 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. 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’.
How Do You Calculate Return On Capital Employed?
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 Biomass Energy Project:
0.034 = zł761k ÷ (zł29m – zł7.2m) (Based on the trailing twelve months to December 2019.)
Therefore, Biomass Energy Project has an ROCE of 3.4%.
Is Biomass Energy Project’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Biomass Energy Project’s ROCE appears meaningfully below the 8.6% average reported by the Food industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Biomass Energy Project’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.
Biomass Energy Project’s current ROCE of 3.4% is lower than 3 years ago, when the company reported a 7.8% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Biomass Energy Project’s ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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, after all, simply a snap shot of a single year. How cyclical is Biomass Energy Project? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Biomass Energy Project’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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Biomass Energy Project has total assets of zł29m and current liabilities of zł7.2m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Biomass Energy Project’s ROCE
Biomass Energy Project has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than Biomass Energy Project. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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