Shareholders Should Look Hard At Algonquin Power & Utilities Corp.’s (TSE:AQN) 4.4% Return On Capital
Today we’ll evaluate Algonquin Power & Utilities Corp. (TSE:AQN) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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?
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 Algonquin Power & Utilities:
0.044 = US$381m ÷ (US$9.1b – US$422m) (Based on the trailing twelve months to September 2018.)
Therefore, Algonquin Power & Utilities has an ROCE of 4.4%.
View our latest analysis for Algonquin Power & Utilities
Want to help shape the future of investing tools? Participate in a short research study and receive a 6-month subscription to the award winning Simply Wall St research tool (valued at $60)!
Is Algonquin Power & Utilities’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Algonquin Power & Utilities’s ROCE appears meaningfully below the 5.6% average reported by the Integrated Utilities industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Algonquin Power & Utilities compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. There are potentially more appealing investments elsewhere.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Algonquin Power & Utilities.
Algonquin Power & Utilities’s Current Liabilities And Their Impact On 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. 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.
Algonquin Power & Utilities has total assets of US$9.1b and current liabilities of US$422m. Therefore its current liabilities are equivalent to approximately 4.7% of its total assets. With barely any current liabilities, there is minimal impact on Algonquin Power & Utilities’s admittedly low ROCE.
The Bottom Line On Algonquin Power & Utilities’s ROCE
Nevertheless, there are potentially more attractive companies to invest in. But note: Algonquin Power & Utilities may not be the best stock to buy. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.