Today we are going to look at Terna - Rete Elettrica Nazionale Società per Azioni (BIT:TRN) to see whether it might be an attractive investment prospect. 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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.
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 Terna - Rete Elettrica Nazionale Società per Azioni:
0.089 = €1.2b ÷ (€15b - €2.0b) (Based on the trailing twelve months to March 2020.)
Therefore, Terna - Rete Elettrica Nazionale Società per Azioni has an ROCE of 8.9%.
Does Terna - Rete Elettrica Nazionale Società per Azioni Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Terna - Rete Elettrica Nazionale Società per Azioni's ROCE appears to be substantially greater than the 7.3% average in the Electric Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the industry comparison for now, Terna - Rete Elettrica Nazionale Società per Azioni's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
You can click on the image below to see (in greater detail) how Terna - Rete Elettrica Nazionale Società per Azioni's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Terna - Rete Elettrica Nazionale Società per Azioni's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Terna - Rete Elettrica Nazionale Società per Azioni has current liabilities of €2.0b and total assets of €15b. As a result, its current liabilities are equal to approximately 13% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Terna - Rete Elettrica Nazionale Società per Azioni's ROCE
If Terna - Rete Elettrica Nazionale Società per Azioni continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Terna - Rete Elettrica Nazionale Società per Azioni. 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.
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.
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. Thank you for reading.