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What Can We Make Of NRG Energy, Inc.’s (NYSE:NRG) High Return On Capital?

Simply Wall St
·4 mins read

Today we'll look at NRG Energy, Inc. (NYSE:NRG) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

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.

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 NRG Energy:

0.17 = US$1.2b ÷ (US$9.5b - US$2.6b) (Based on the trailing twelve months to September 2019.)

So, NRG Energy has an ROCE of 17%.

View our latest analysis for NRG Energy

Does NRG Energy Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, NRG Energy's ROCE is meaningfully higher than the 6.7% average in the Renewable Energy industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from NRG Energy's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

We can see that, NRG Energy currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 4.0%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how NRG Energy's ROCE compares to its industry. Click to see more on past growth.

NYSE:NRG Past Revenue and Net Income, February 5th 2020
NYSE:NRG Past Revenue and Net Income, February 5th 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. 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.

NRG Energy's Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.

NRG Energy has total assets of US$9.5b and current liabilities of US$2.6b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On NRG Energy's ROCE

This is good to see, and with a sound ROCE, NRG Energy could be worth a closer look. NRG Energy shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.