Today we'll look at MGE Energy, Inc. (NASDAQ:MGEE) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?
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 MGE Energy:
0.062 = US$118m ÷ (US$2.1b - US$152m) (Based on the trailing twelve months to September 2019.)
Therefore, MGE Energy has an ROCE of 6.2%.
Is MGE Energy's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that MGE Energy's ROCE is meaningfully better than the 4.6% average in the Electric Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Aside from the industry comparison, MGE Energy'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.
The image below shows how MGE Energy's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is, after all, simply a snap shot of a single year. You can check if MGE Energy has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How MGE Energy's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
MGE Energy has total liabilities of US$152m and total assets of US$2.1b. As a result, its current liabilities are equal to approximately 7.4% of its total assets. MGE Energy has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On MGE Energy's ROCE
If performance improves, then MGE Energy may be an OK investment, especially at the right valuation. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
MGE Energy is not the only stock that insiders are buying. 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.
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