Today we are going to look at Northwest Natural Holding Company (NYSE:NWN) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. 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 Northwest Natural Holding:
0.038 = US$113m ÷ (US$3.4b - US$482m) (Based on the trailing twelve months to December 2019.)
So, Northwest Natural Holding has an ROCE of 3.8%.
Is Northwest Natural Holding's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Northwest Natural Holding's ROCE is meaningfully below the Gas Utilities industry average of 5.5%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Northwest Natural Holding compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. Readers may wish to look for more rewarding investments.
Northwest Natural Holding's current ROCE of 3.8% is lower than 3 years ago, when the company reported a 5.1% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Northwest Natural Holding's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 Northwest Natural Holding.
How Northwest Natural Holding's Current Liabilities Impact 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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Northwest Natural Holding has total assets of US$3.4b and current liabilities of US$482m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Northwest Natural Holding's ROCE
Northwest Natural Holding has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Northwest Natural Holding better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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