This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between NRG Energy Inc (NYSE:NRG)’s return fundamentals and stock market performance.
If you purchase a NRG share you are effectively becoming a partner with many other shareholders. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. Your return is tied to NRG’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Thus, to understand how your money can grow by investing in NRG Energy, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
ROCE: Explanation and Calculation
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. We’ll look at NRG Energy’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:
ROCE Calculation for NRG
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$754.00m ÷ (US$23.75b – US$3.71b) = 3.76%
The calculation above shows that NRG’s earnings were 3.76% of capital employed. This makes NRG Energy disappointing when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital may be able to compound over time, but not to standard that investors should be aiming for.
Why is this the case?
Although NRG Energy is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking three years in the past, it is evident that NRG’s ROCE has risen from 0.63%, indicating the company’s capital returns have stengthened. Similarly, the movement in the earnings variable shows a jump from US$225.00m to US$754.00m whilst the amount of capital employed has decreased as a result of a decreased level of total assets , which means the company has been able to improve ROCE by growing earnings and simultaneously putting less capital to work.
ROCE for NRG investors is below the desired level at the moment, however, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation to determine whether there is potential for return by focusing our attention elsewhere. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate NRG or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for NRG’s future growth? Take a look at our free research report of analyst consensus for NRG’s outlook.
- Valuation: What is NRG worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether NRG is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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 email@example.com.