Today we’ll evaluate Terna – Rete Elettrica Nazionale Società per Azioni (BIT:TRN) 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.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Terna – Rete Elettrica Nazionale Società per Azioni:
0.084 = €1.1b ÷ (€16b – €2.8b) (Based on the trailing twelve months to September 2018.)
Therefore, Terna – Rete Elettrica Nazionale Società per Azioni has an ROCE of 8.4%.
Is Terna – Rete Elettrica Nazionale Società per Azioni’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Terna – Rete Elettrica Nazionale Società per Azioni’s ROCE is fairly close to the Electric Utilities industry average of 7.1%. Setting aside the industry comparison for now, Terna – Rete Elettrica Nazionale Società per Azioni’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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 free report on analyst forecasts for Terna – Rete Elettrica Nazionale Società per Azioni.
Do Terna – Rete Elettrica Nazionale Società per Azioni’s Current Liabilities Skew 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Terna – Rete Elettrica Nazionale Società per Azioni has total liabilities of €2.8b and total assets of €16b. Therefore its current liabilities are equivalent 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 Terna – Rete Elettrica Nazionale Società per Azioni’s ROCE
With that in mind, we’re not overly impressed with Terna – Rete Elettrica Nazionale Società per Azioni’s ROCE, so it may not be the most appealing prospect. But note: Terna – Rete Elettrica Nazionale Società per Azioni may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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.