Why BQE Water Inc.’s (CVE:BQE) Return On Capital Employed Might Be A Concern

Today we’ll look at BQE Water Inc. (CVE:BQE) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 BQE Water:

0.017 = CA$109k ÷ (CA$8.3m – CA$1.7m) (Based on the trailing twelve months to June 2019.)

Therefore, BQE Water has an ROCE of 1.7%.

Check out our latest analysis for BQE Water

Is BQE Water’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see BQE Water’s ROCE is meaningfully below the Commercial Services industry average of 7.9%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how BQE Water stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

BQE Water delivered an ROCE of 1.7%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can see in the image below how BQE Water’s ROCE compares to its industry.

TSXV:BQE Past Revenue and Net Income, September 22nd 2019
TSXV:BQE Past Revenue and Net Income, September 22nd 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. If BQE Water is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect BQE Water’s ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

BQE Water has total liabilities of CA$1.7m and total assets of CA$8.3m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

What We Can Learn From BQE Water’s ROCE

While that is good to see, BQE Water has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than BQE Water. 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).

There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.

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.

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. Thank you for reading.