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Canadian Solar Inc. (NASDAQ:CSIQ) Is Employing Capital Very Effectively

Brandon Murphy

Today we’ll look at Canadian Solar Inc. (NASDAQ:CSIQ) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Canadian Solar:

0.22 = US$250m ÷ (US$5.2b – US$3.6b) (Based on the trailing twelve months to September 2018.)

So, Canadian Solar has an ROCE of 22%.

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Does Canadian Solar Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Canadian Solar’s ROCE appears to be substantially greater than the 14% average in the Semiconductor industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Canadian Solar’s ROCE is currently very good.

As we can see, Canadian Solar currently has an ROCE of 22% compared to its ROCE 3 years ago, which was 17%. This makes us wonder if the company is improving.

NasdaqGS:CSIQ Last Perf January 22nd 19

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Canadian Solar.

How Canadian Solar’s Current Liabilities Impact 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Canadian Solar has total assets of US$5.2b and current liabilities of US$3.6b. As a result, its current liabilities are equal to approximately 70% of its total assets. While a high level of current liabilities boosts its ROCE, Canadian Solar’s returns are still very good.

Our Take On Canadian Solar’s ROCE

So to us, the company is potentially worth investigating further. But note: Canadian Solar may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.