What Can We Make Of Trustpower Limited’s (NZSE:TPW) High Return On Capital?
Today we are going to look at Trustpower Limited (NZSE:TPW) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Trustpower:
0.073 = NZ$144m ÷ (NZ$2.1b - NZ$144m) (Based on the trailing twelve months to March 2020.)
Therefore, Trustpower has an ROCE of 7.3%.
Check out our latest analysis for Trustpower
Is Trustpower's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Trustpower's ROCE appears to be substantially greater than the 4.5% average in the Electric Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how Trustpower stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
The image below shows how Trustpower'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, 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 Trustpower.
Trustpower's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Trustpower has current liabilities of NZ$144m and total assets of NZ$2.1b. Therefore its current liabilities are equivalent to approximately 6.8% of its total assets. With low levels of current liabilities, at least Trustpower's mediocre ROCE is not unduly boosted.
The Bottom Line On Trustpower's ROCE
Trustpower looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than Trustpower. So you may wish to see this free collection of other companies that have grown earnings strongly.
Trustpower is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.
