Today we'll evaluate California Water Service Group (NYSE:CWT) 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 California Water Service Group:
0.043 = US$114m ÷ (US$3.0b - US$334m) (Based on the trailing twelve months to September 2019.)
Therefore, California Water Service Group has an ROCE of 4.3%.
Is California Water Service Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, California Water Service Group's ROCE appears to be around the 4.1% average of the Water Utilities industry. Independently of how California Water Service Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. It is likely that there are more attractive prospects out there.
You can click on the image below to see (in greater detail) how California Water Service Group's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for California Water Service Group.
What Are Current Liabilities, And How Do They Affect California Water Service Group's 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
California Water Service Group has total assets of US$3.0b and current liabilities of US$334m. As a result, its current liabilities are equal to approximately 11% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On California Water Service Group's ROCE
California Water Service Group has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than California Water Service Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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