Today we'll look at Avangrid, Inc. (NYSE:AGR) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Avangrid:
0.031 = US$943m ÷ (US$34b - US$2.8b) (Based on the trailing twelve months to September 2019.)
So, Avangrid has an ROCE of 3.1%.
Does Avangrid Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Avangrid's ROCE appears meaningfully below the 4.6% average reported by the Electric Utilities industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Avangrid's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
You can click on the image below to see (in greater detail) how Avangrid's past growth compares to other companies.
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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Avangrid.
What Are Current Liabilities, And How Do They Affect Avangrid's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Avangrid has total assets of US$34b and current liabilities of US$2.8b. Therefore its current liabilities are equivalent to approximately 8.5% of its total assets. Avangrid has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From Avangrid's ROCE
Nonetheless, there may be better places to invest your capital. You might be able to find a better investment than Avangrid. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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