Is EnviTec Biogas AG (FRA:ETG) Better Than Average At Deploying Capital?

Today we'll look at EnviTec Biogas AG (FRA:ETG) 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. Then we'll compare its ROCE to similar companies. 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. Generally speaking a higher ROCE is better. 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?

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 EnviTec Biogas:

0.048 = €6.4m ÷ (€269m - €46m) (Based on the trailing twelve months to June 2018.)

So, EnviTec Biogas has an ROCE of 4.8%.

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Does EnviTec Biogas Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. It appears that EnviTec Biogas's ROCE is fairly close to the Oil and Gas industry average of 5.1%. Separate from how EnviTec Biogas stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Our data shows that EnviTec Biogas currently has an ROCE of 4.8%, compared to its ROCE of 1.2% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

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. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like EnviTec Biogas are cyclical businesses. If EnviTec Biogas is cyclical, it could make sense to check out this freegraph of past earnings, revenue and cash flow.

How EnviTec Biogas'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.

EnviTec Biogas has total liabilities of €46m and total assets of €269m. As a result, its current liabilities are equal to approximately 17% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On EnviTec Biogas's ROCE

That said, EnviTec Biogas's ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than EnviTec Biogas. So you may wish to see this freecollection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this freelist of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.