Today we are going to look at ALLETE, Inc. (NYSE:ALE) to see whether it might be an attractive investment prospect. 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.
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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 ALLETE:
0.042 = US$202m ÷ (US$5.3b - US$483m) (Based on the trailing twelve months to September 2019.)
So, ALLETE has an ROCE of 4.2%.
Does ALLETE Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see ALLETE's ROCE is around the 4.6% average reported by the Electric Utilities industry. Independently of how ALLETE compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. There are potentially more appealing investments elsewhere.
You can see in the image below how ALLETE's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 ALLETE.
How ALLETE's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
ALLETE has total liabilities of US$483m and total assets of US$5.3b. As a result, its current liabilities are equal to approximately 9.2% of its total assets. With barely any current liabilities, there is minimal impact on ALLETE's admittedly low ROCE.
Our Take On ALLETE's ROCE
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