Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we'll evaluate Aqua America, Inc. (NYSE:WTR) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its 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?
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 Aqua America:
0.049 = US$327m ÷ (US$7.1b - US$434m) (Based on the trailing twelve months to March 2019.)
So, Aqua America has an ROCE of 4.9%.
Is Aqua America's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Aqua America's ROCE is fairly close to the Water Utilities industry average of 4.9%. Regardless of how Aqua America stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
The image below shows how Aqua America's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Aqua America.
Aqua America's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Aqua America has total assets of US$7.1b and current liabilities of US$434m. Therefore its current liabilities are equivalent to approximately 6.1% of its total assets. Aqua America has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Aqua America's ROCE
Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better investment than Aqua America. 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).
I will like Aqua America better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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. Thank you for reading.