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Today we'll evaluate Biomass Energy Project S.A. (WSE:BEP) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. 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'.
How Do You Calculate Return On Capital Employed?
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 Biomass Energy Project:
0.029 = zł664k ÷ (zł28m - zł5.7m) (Based on the trailing twelve months to December 2018.)
So, Biomass Energy Project has an ROCE of 2.9%.
Does Biomass Energy Project Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Biomass Energy Project's ROCE appears meaningfully below the 13% average reported by the Food industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Biomass Energy Project compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.9% available in government bonds. There are potentially more appealing investments elsewhere.
As we can see, Biomass Energy Project currently has an ROCE of 2.9%, less than the 27% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
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. How cyclical is Biomass Energy Project? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Biomass Energy Project's Current Liabilities Impact Its 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Biomass Energy Project has total liabilities of zł5.7m and total assets of zł28m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From Biomass Energy Project's ROCE
That's not a bad thing, however Biomass Energy Project has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than Biomass Energy Project. 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).
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 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.