Examining EDP – Energias de Portugal, S.A.’s (ELI:EDP) Weak Return On Capital Employed
Today we’ll look at EDP – Energias de Portugal, S.A. (ELI:EDP) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding 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. 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?
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 EDP – Energias de Portugal:
0.031 = €1.5b ÷ (€41b – €7.0b) (Based on the trailing twelve months to September 2018.)
Therefore, EDP – Energias de Portugal has an ROCE of 3.1%.
Check out our latest analysis for EDP – Energias de Portugal
Want to help shape the future of investing tools and platforms? Take the survey and be part of one of the most advanced studies of stock market investors to date.
Does EDP – Energias de Portugal Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see EDP – Energias de Portugal’s ROCE is meaningfully below the Electric Utilities industry average of 7.2%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how EDP – Energias de Portugal stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
EDP – Energias de Portugal’s current ROCE of 3.1% is lower than its ROCE in the past, which was 5.3%, 3 years ago. So investors might consider if it has had issues recently.
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 EDP – Energias de Portugal.
How EDP – Energias de Portugal’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
EDP – Energias de Portugal has total liabilities of €7.0b and total assets of €41b. As a result, its current liabilities are equal to approximately 17% 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 EDP – Energias de Portugal’s ROCE
EDP – Energias de Portugal has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better buy than EDP – Energias de Portugal. 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 EDP – Energias de Portugal better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.
