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Today we'll look at Black Hills Corporation (NYSE:BKH) and reflect on its potential as an investment. 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, 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.
Return On Capital Employed (ROCE): What is it?
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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 Black Hills:
0.063 = US$406m ÷ (US$7.0b - US$591m) (Based on the trailing twelve months to March 2019.)
So, Black Hills has an ROCE of 6.3%.
Does Black Hills Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Black Hills's ROCE is meaningfully higher than the 5.2% average in the Integrated Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how Black Hills stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
Our data shows that Black Hills currently has an ROCE of 6.3%, compared to its ROCE of 4.9% 3 years ago. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Black Hills.
Black Hills'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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Black Hills has total assets of US$7.0b and current liabilities of US$591m. As a result, its current liabilities are equal to approximately 8.4% of its total assets. With low levels of current liabilities, at least Black Hills's mediocre ROCE is not unduly boosted.
What We Can Learn From Black Hills's ROCE
Based on this information, Black Hills appears to be a mediocre business. Of course, you might also be able to find a better stock than Black Hills. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.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.