In This Article:
Today we'll evaluate Aquila SA (EPA:ALAQU) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 Aquila:
0.39 = €882k ÷ (€8.1m - €5.9m) (Based on the trailing twelve months to December 2018.)
So, Aquila has an ROCE of 39%.
See our latest analysis for Aquila
Is Aquila's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Aquila's ROCE appears to be substantially greater than the 7.8% average in the Commercial Services 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. Putting aside its position relative to its industry for now, in absolute terms, Aquila's ROCE is currently very good.
We can see that, Aquila currently has an ROCE of 39% compared to its ROCE 3 years ago, which was 30%. This makes us think the business might be improving. The image below shows how Aquila's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. How cyclical is Aquila? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Aquila's Current Liabilities Impact Its 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.