Today we'll evaluate Southwest Gas Holdings, Inc. (NYSE:SWX) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Southwest Gas Holdings:
0.054 = US$356m ÷ (US$7.6b - US$974m) (Based on the trailing twelve months to March 2019.)
Therefore, Southwest Gas Holdings has an ROCE of 5.4%.
Does Southwest Gas Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Southwest Gas Holdings's ROCE is fairly close to the Gas Utilities industry average of 5.8%. Independently of how Southwest Gas Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
The image below shows how Southwest Gas Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Southwest Gas Holdings.
Southwest Gas Holdings's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Southwest Gas Holdings has total liabilities of US$974m and total assets of US$7.6b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From Southwest Gas Holdings's ROCE
Southwest Gas Holdings 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 Southwest Gas Holdings. 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.