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Is Iberdrola, S.A. (BME:IBE) Better Than Average At Deploying Capital?

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Simply Wall St
·4 min read
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Today we'll look at Iberdrola, S.A. (BME:IBE) 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.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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 Iberdrola:

0.059 = €6.0b ÷ (€119b - €18b) (Based on the trailing twelve months to September 2019.)

Therefore, Iberdrola has an ROCE of 5.9%.

Check out our latest analysis for Iberdrola

Does Iberdrola Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Iberdrola's ROCE is meaningfully below the Electric Utilities industry average of 7.4%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Iberdrola stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

The image below shows how Iberdrola's ROCE compares to its industry, and you can click it to see more detail on its past growth.

BME:IBE Past Revenue and Net Income, February 17th 2020
BME:IBE Past Revenue and Net Income, February 17th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Iberdrola.

Do Iberdrola's Current Liabilities Skew 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Iberdrola has current liabilities of €18b and total assets of €119b. Therefore its current liabilities are equivalent to approximately 15% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Iberdrola's ROCE

If Iberdrola continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Iberdrola better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.