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Iren SpA (BIT:IRE) Earns Among The Best Returns In Its Industry

Today we'll look at Iren SpA (BIT:IRE) 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.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Iren:

0.066 = €457m ÷ (€8.4b - €1.5b) (Based on the trailing twelve months to September 2019.)

So, Iren has an ROCE of 6.6%.

View our latest analysis for Iren

Is Iren's ROCE Good?

One way to assess ROCE is to compare similar companies. Iren's ROCE appears to be substantially greater than the 5.2% average in the Integrated Utilities 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. Aside from the industry comparison, Iren's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

You can see in the image below how Iren's ROCE compares to its industry. Click to see more on past growth.

BIT:IRE Past Revenue and Net Income, February 26th 2020
BIT:IRE Past Revenue and Net Income, February 26th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Iren.

Iren's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Iren has current liabilities of €1.5b and total assets of €8.4b. As a result, its current liabilities are equal to approximately 18% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Iren's ROCE

If Iren continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Iren. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Iren 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 editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.