Is Siemens Gamesa Renewable Energy, S.A. (BME:SGRE) Struggling With Its 3.5% Return On Capital Employed?

Today we'll look at Siemens Gamesa Renewable Energy, S.A. (BME:SGRE) 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. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Siemens Gamesa Renewable Energy:

0.035 = €320m ÷ (€16b - €7.1b) (Based on the trailing twelve months to September 2018.)

Therefore, Siemens Gamesa Renewable Energy has an ROCE of 3.5%.

Check out our latest analysis for Siemens Gamesa Renewable Energy

Does Siemens Gamesa Renewable Energy Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Siemens Gamesa Renewable Energy's ROCE is meaningfully below the Electrical industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Siemens Gamesa Renewable Energy'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.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our freereport on analyst forecasts for Siemens Gamesa Renewable Energy.

What Are Current Liabilities, And How Do They Affect Siemens Gamesa Renewable Energy's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Siemens Gamesa Renewable Energy has total liabilities of €7.1b and total assets of €16b. Therefore its current liabilities are equivalent to approximately 44% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Siemens Gamesa Renewable Energy's ROCE is concerning.

Our Take On Siemens Gamesa Renewable Energy's ROCE

There are likely better investments out there. Of course you might be able to find a better stock than Siemens Gamesa Renewable Energy. So you may wish to see this freecollection of other companies that have grown earnings strongly.

I will like Siemens Gamesa Renewable Energy better if I see some big insider buys. While we wait, check out this freelist of growing companies with considerable, recent, insider buying.

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.