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Today we’ll look at CenterPoint Energy, Inc. (NYSE:CNP) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. 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.’
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 CenterPoint Energy:
0.048 = US$1.1b ÷ (US$22b – US$2.6b) (Based on the trailing twelve months to September 2018.)
So, CenterPoint Energy has an ROCE of 4.8%.
Is CenterPoint Energy’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, CenterPoint Energy’s ROCE appears to be around the 5.5% average of the Integrated Utilities industry. Independently of how CenterPoint Energy compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. Readers may wish to look for more rewarding investments.
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. 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 CenterPoint Energy.
What Are Current Liabilities, And How Do They Affect CenterPoint Energy’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
CenterPoint Energy has total assets of US$22b and current liabilities of US$2.6b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On CenterPoint Energy’s ROCE
CenterPoint Energy has a poor ROCE, and there may be better investment prospects out there. Of course you might be able to find a better stock than CenterPoint Energy. 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).
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.