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Shareholders Should Look Hard At E.ON SE’s (ETR:EOAN) 1.9%Return On Capital

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Simply Wall St
·4 min read
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Today we are going to look at E.ON SE (ETR:EOAN) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 E.ON:

0.019 = €1.4b ÷ (€99b - €26b) (Based on the trailing twelve months to December 2019.)

So, E.ON has an ROCE of 1.9%.

View our latest analysis for E.ON

Is E.ON's ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, E.ON's ROCE appears meaningfully below the 5.1% 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. Regardless of how E.ON stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

E.ON reported an ROCE of 1.9% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how E.ON's past growth compares to other companies.

XTRA:EOAN Past Revenue and Net Income May 13th 2020
XTRA:EOAN Past Revenue and Net Income May 13th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do E.ON's Current Liabilities Skew 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

E.ON has total assets of €99b and current liabilities of €26b. As a result, its current liabilities are equal to approximately 26% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

The Bottom Line On E.ON's ROCE

That's not a bad thing, however E.ON has a weak ROCE and may not be an attractive investment. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.