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Today we are going to look at Renewable Energy Group, Inc. (NASDAQ:REGI) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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’.
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 Renewable Energy Group:
0.32 = -US$20.5m ÷ (US$1.1b – US$310m) (Based on the trailing twelve months to September 2018.)
Therefore, Renewable Energy Group has an ROCE of 32%.
Does Renewable Energy Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Renewable Energy Group’s ROCE is meaningfully better than the 6.6% average in the Oil and Gas 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. Setting aside the comparison to its industry for a moment, Renewable Energy Group’s ROCE in absolute terms currently looks quite high.
In our analysis, Renewable Energy Group’s ROCE appears to be 32%, compared to 3 years ago, when its ROCE was 2.3%. This makes us wonder if the company is improving.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. We note Renewable Energy Group could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Renewable Energy Group.
Do Renewable Energy Group’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Renewable Energy Group has total assets of US$1.1b and current liabilities of US$310m. As a result, its current liabilities are equal to approximately 27% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Renewable Energy Group’s ROCE
With low current liabilities and a high ROCE, Renewable Energy Group could be worthy of further investigation. You might be able to find a better buy than Renewable Energy Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org. 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.