Here’s why Evoqua Water Technologies Corp.’s (NYSE:AQUA) Returns On Capital Matters So Much

Today we are going to look at Evoqua Water Technologies Corp. (NYSE:AQUA) to see whether it might be an attractive investment prospect. 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.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Evoqua Water Technologies:

0.069 = US$96m ÷ (US$1.7b – US$285m) (Based on the trailing twelve months to September 2018.)

Therefore, Evoqua Water Technologies has an ROCE of 6.9%.

Check out our latest analysis for Evoqua Water Technologies

Is Evoqua Water Technologies’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Evoqua Water Technologies’s ROCE appears meaningfully below the 12% average reported by the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Evoqua Water Technologies stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Our data shows that Evoqua Water Technologies currently has an ROCE of 6.9%, compared to its ROCE of 1.2% 3 years ago. This makes us wonder if the company is improving.

NYSE:AQUA Last Perf January 25th 19
NYSE:AQUA Last Perf January 25th 19

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 Evoqua Water Technologies.

What Are Current Liabilities, And How Do They Affect Evoqua Water Technologies’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Evoqua Water Technologies has total assets of US$1.7b and current liabilities of US$285m. As a result, its current liabilities are equal to approximately 17% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Evoqua Water Technologies’s ROCE

With that in mind, we’re not overly impressed with Evoqua Water Technologies’s ROCE, so it may not be the most appealing prospect. But note: Evoqua Water Technologies 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.