Today we’ll look at Connecticut Water Service, Inc. (NASDAQ:CTWS) 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.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Connecticut Water Service:
0.039 = US$31m ÷ (US$944m – US$77m) (Based on the trailing twelve months to September 2018.)
So, Connecticut Water Service has an ROCE of 3.9%.
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Is Connecticut Water Service’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Connecticut Water Service’s ROCE appears meaningfully below the 5.2% average reported by the Water Utilities industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Connecticut Water Service stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Connecticut Water Service.
Connecticut Water Service’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Connecticut Water Service has total assets of US$944m and current liabilities of US$77m. Therefore its current liabilities are equivalent to approximately 8.1% of its total assets. Connecticut Water Service has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From Connecticut Water Service’s ROCE
Still, investors could probably find more attractive prospects with better performance out there. Of course you might be able to find a better stock than Connecticut Water Service. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.com.