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Is Emera Incorporated’s (TSE:EMA) 5.0% Return On Capital Employed Good News?

Simply Wall St

Today we'll look at Emera Incorporated (TSE:EMA) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. 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 Emera:

0.05 = CA$1.4b ÷ (CA$32b - CA$4.0b) (Based on the trailing twelve months to September 2019.)

Therefore, Emera has an ROCE of 5.0%.

View our latest analysis for Emera

Is Emera's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Emera's ROCE is around the 4.7% average reported by the Electric Utilities industry. Separate from how Emera stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Our data shows that Emera currently has an ROCE of 5.0%, compared to its ROCE of 2.1% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Emera's ROCE compares to its industry. Click to see more on past growth.

TSX:EMA Past Revenue and Net Income, January 8th 2020

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Emera'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Emera has total liabilities of CA$4.0b and total assets of CA$32b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From Emera's ROCE

With that in mind, we're not overly impressed with Emera's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Emera. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.