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Today we are going to look at EnBW Energie Baden-Württemberg AG (FRA:EBK) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to 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 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?
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 EnBW Energie Baden-Württemberg:
0.023 = €676m ÷ (€40b – €11b) (Based on the trailing twelve months to March 2019.)
Therefore, EnBW Energie Baden-Württemberg has an ROCE of 2.3%.
Does EnBW Energie Baden-Württemberg Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, EnBW Energie Baden-Württemberg’s ROCE appears to be significantly below the 7.4% average in the Electric Utilities industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how EnBW Energie Baden-Württemberg compares to its industry, its ROCE in absolute terms is low; especially compared to the ~0.2% available in government bonds. There are potentially more appealing investments elsewhere.
It is important to remember that ROCE shows past performance, and is 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. If EnBW Energie Baden-Württemberg is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do EnBW Energie Baden-Württemberg’s Current Liabilities Skew Its 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.
EnBW Energie Baden-Württemberg has total liabilities of €11b and total assets of €40b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From EnBW Energie Baden-Württemberg’s ROCE
While that is good to see, EnBW Energie Baden-Württemberg has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than EnBW Energie Baden-Württemberg. 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).
I will like EnBW Energie Baden-Württemberg better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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. Thank you for reading.