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Today we'll look at MGE Energy, Inc. (NASDAQ:MGEE) 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.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. 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?
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 MGE Energy:
0.067 = US$125m ÷ (US$2.0b - US$121m) (Based on the trailing twelve months to December 2018.)
So, MGE Energy has an ROCE of 6.7%.
Does MGE Energy Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that MGE Energy's ROCE is meaningfully better than the 4.8% average in the Electric Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how MGE Energy stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. You can check if MGE Energy has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
MGE Energy'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
MGE Energy has total liabilities of US$121m and total assets of US$2.0b. As a result, its current liabilities are equal to approximately 6.1% of its total assets. MGE Energy reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From MGE Energy's ROCE
If performance improves, then MGE Energy may be an OK investment, especially at the right valuation. You might be able to find a better buy than MGE Energy. 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).
I will like MGE Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.