Today we'll evaluate Infigen Energy Limited (ASX:IFN) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. 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 Infigen Energy:
0.094 = AU$111m ÷ (AU$1.3b - AU$98m) (Based on the trailing twelve months to June 2019.)
Therefore, Infigen Energy has an ROCE of 9.4%.
Does Infigen Energy Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Infigen Energy's ROCE appears to be around the 9.1% average of the Renewable Energy industry. Independently of how Infigen Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Infigen Energy currently has an ROCE of 9.4%, compared to its ROCE of 6.6% 3 years ago. This makes us wonder if the company is improving. You can see in the image below how Infigen Energy's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Infigen Energy'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Infigen Energy has total assets of AU$1.3b and current liabilities of AU$98m. Therefore its current liabilities are equivalent to approximately 7.7% of its total assets. Low current liabilities have only a minimal impact on Infigen Energy's ROCE, making its decent returns more credible.
The Bottom Line On Infigen Energy's ROCE
This is good to see, and while better prospects may exist, Infigen Energy seems worth researching further. Infigen 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.
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.
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.