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Today we’ll look at E.ON SE (FRA:EOAN) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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’.
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 E.ON:
0.082 = €1.6b ÷ (€53b – €13b) (Based on the trailing twelve months to September 2018.)
Therefore, E.ON has an ROCE of 8.2%.
Does E.ON Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, E.ON’s ROCE is meaningfully higher than the 5.1% average in the Integrated Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how E.ON compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
E.ON delivered an ROCE of 8.2%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 E.ON.
How E.ON’s Current Liabilities Impact Its 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.
E.ON has total liabilities of €13b and total assets of €53b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On E.ON’s ROCE
This is good to see, and with a sound ROCE, E.ON could be worth a closer look. Of course you might be able to find a better stock than E.ON. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.