Today we’ll evaluate Grenergy Renovables, S.A. (BME:GRE) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its 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?
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 Grenergy Renovables:
0.20 = €12m ÷ (€110m – €47m) (Based on the trailing twelve months to June 2019.)
So, Grenergy Renovables has an ROCE of 20%.
Does Grenergy Renovables Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Grenergy Renovables’s ROCE is meaningfully higher than the 4.1% average in the Renewable Energy industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Grenergy Renovables’s ROCE is currently very good.
Grenergy Renovables reported an ROCE of 20% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving. You can see in the image below how Grenergy Renovables’s ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Grenergy Renovables.
Grenergy Renovables’s Current Liabilities And Their Impact On 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. 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.
Grenergy Renovables has current liabilities of €47m and total assets of €110m. As a result, its current liabilities are equal to approximately 43% of its total assets. A medium level of current liabilities boosts Grenergy Renovables’s ROCE somewhat.
What We Can Learn From Grenergy Renovables’s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. Grenergy Renovables shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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