Are American Electric Power Company, Inc.’s Returns On Capital Worth Investigating?

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Today we’ll evaluate American Electric Power Company, Inc. (NYSE:AEP) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

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.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 American Electric Power Company:

0.047 = US$3.0b ÷ (US$71b – US$8.0b) (Based on the trailing twelve months to March 2019.)

Therefore, American Electric Power Company has an ROCE of 4.7%.

View our latest analysis for American Electric Power Company

Does American Electric Power Company Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see American Electric Power Company’s ROCE is around the 4.7% average reported by the Electric Utilities industry. Putting aside American Electric Power Company’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

NYSE:AEP Past Revenue and Net Income, June 3rd 2019
NYSE:AEP Past Revenue and Net Income, June 3rd 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for American Electric Power Company.

What Are Current Liabilities, And How Do They Affect American Electric Power Company’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.

American Electric Power Company has total assets of US$71b and current liabilities of US$8.0b. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

Our Take On American Electric Power Company’s ROCE

That’s not a bad thing, however American Electric Power Company has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than American Electric Power Company. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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 editorial-team@simplywallst.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.