Today we are going to look at 2G Energy AG (ETR:2GB) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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?
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 2G Energy:
0.19 = €13m ÷ (€135m - €66m) (Based on the trailing twelve months to June 2019.)
So, 2G Energy has an ROCE of 19%.
Does 2G Energy Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, 2G Energy's ROCE appears to be around the 16% average of the Electrical industry. Putting aside its position relative to its industry for now, in absolute terms, 2G Energy's ROCE is currently very good.
Our data shows that 2G Energy currently has an ROCE of 19%, compared to its ROCE of 11% 3 years ago. This makes us think the business might be improving. You can see in the image below how 2G Energy's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for 2G Energy.
What Are Current Liabilities, And How Do They Affect 2G Energy's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
2G Energy has total liabilities of €66m and total assets of €135m. As a result, its current liabilities are equal to approximately 49% of its total assets. 2G Energy has a medium level of current liabilities, boosting its ROCE somewhat.
Our Take On 2G Energy's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than 2G Energy out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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