In This Article:
Today we'll look at ENCE Energía y Celulosa, S.A. (BME:ENC) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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'.
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 ENCE Energía y Celulosa:
0.15 = €197m ÷ (€1.7b - €444m) (Based on the trailing twelve months to December 2018.)
Therefore, ENCE Energía y Celulosa has an ROCE of 15%.
Check out our latest analysis for ENCE Energía y Celulosa
Is ENCE Energía y Celulosa's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, ENCE Energía y Celulosa's ROCE is meaningfully higher than the 8.8% average in the Forestry 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. Separate from ENCE Energía y Celulosa's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for ENCE Energía y Celulosa.
How ENCE Energía y Celulosa'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. 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.