Today we'll look at Enphase Energy, Inc. (NASDAQ:ENPH) and reflect on its potential as an investment. 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, 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 measures the 'return' (pre-tax profit) a company generates from capital employed 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'.
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 Enphase Energy:
0.17 = US$64m ÷ (US$524m - US$147m) (Based on the trailing twelve months to September 2019.)
So, Enphase Energy has an ROCE of 17%.
Is Enphase Energy's ROCE Good?
One way to assess ROCE is to compare similar companies. Enphase Energy's ROCE appears to be substantially greater than the 9.9% average in the Semiconductor industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Enphase Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Enphase Energy has an ROCE of 17%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. The image below shows how Enphase Energy's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 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 Enphase Energy.
What Are Current Liabilities, And How Do They Affect Enphase Energy's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Enphase Energy has current liabilities of US$147m and total assets of US$524m. As a result, its current liabilities are equal to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Enphase Energy's ROCE
Overall, Enphase Energy has a decent ROCE and could be worthy of further research. Enphase Energy looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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