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Here’s What Atlantic Power Corporation’s (TSE:ATP) Return On Capital Can Tell Us

Simply Wall St

Today we'll evaluate Atlantic Power Corporation (TSE:ATP) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding 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. Generally speaking a higher ROCE is better. 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.

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 Atlantic Power:

0.049 = US$42m (US$995m - US$146m) (Based on the trailing twelve months to June 2019.)

Therefore, Atlantic Power has an ROCE of 4.9%.

View our latest analysis for Atlantic Power

Does Atlantic Power Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Atlantic Power's ROCE is fairly close to the Renewable Energy industry average of 4.3%. Regardless of how Atlantic Power stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

We can see that, Atlantic Power currently has an ROCE of 4.9% compared to its ROCE 3 years ago, which was 3.4%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Atlantic Power's ROCE compares to its industry. Click to see more on past growth.

TSX:ATP Past Revenue and Net Income, October 3rd 2019

When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Atlantic Power.

Atlantic Power's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Atlantic Power has total liabilities of US$146m and total assets of US$995m. As a result, its current liabilities are equal to approximately 15% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

What We Can Learn From Atlantic Power's ROCE

Atlantic Power has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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 editorial-team@simplywallst.com. 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.