Today we'll evaluate Inspired Energy PLC (LON:INSE) to determine whether it could have potential as an investment idea. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. Ultimately, it is a useful but imperfect metric. 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 Inspired Energy:
0.10 = UK£7.2m ÷ (UK£86m - UK£14m) (Based on the trailing twelve months to December 2018.)
So, Inspired Energy has an ROCE of 10%.
Is Inspired Energy's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Inspired Energy's ROCE appears to be around the 11% average of the Commercial Services industry. Separate from Inspired Energy's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Inspired Energy's current ROCE of 10% is lower than 3 years ago, when the company reported a 19% ROCE. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Inspired Energy's Current Liabilities And Their Impact On Its 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 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.
Inspired Energy has total liabilities of UK£14m and total assets of UK£86m. Therefore its current liabilities are equivalent to approximately 17% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Inspired Energy's ROCE
This is good to see, and with a sound ROCE, Inspired Energy could be worth a closer look. Inspired Energy looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Inspired Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.