Today we'll look at 7C Solarparken AG (ETR:HRPK) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
How Do You Calculate Return On Capital Employed?
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 7C Solarparken:
0.042 = €13m ÷ (€345m - €28m) (Based on the trailing twelve months to December 2018.)
So, 7C Solarparken has an ROCE of 4.2%.
Does 7C Solarparken Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, 7C Solarparken's ROCE appears to be significantly below the 5.5% average in the Renewable Energy industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, 7C Solarparken's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
We can see that , 7C Solarparken currently has an ROCE of 4.2% compared to its ROCE 3 years ago, which was 3.2%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how 7C Solarparken's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for 7C Solarparken.
What Are Current Liabilities, And How Do They Affect 7C Solarparken's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
7C Solarparken has total assets of €345m and current liabilities of €28m. Therefore its current liabilities are equivalent to approximately 8.2% of its total assets. 7C Solarparken has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From 7C Solarparken's ROCE
7C Solarparken looks like an ok business, but on this analysis it is not at the top of our buy list. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. Thank you for reading.