Today we'll look at Exelon Corporation (NASDAQ:EXC) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we 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.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 Exelon:
0.04 = US$4.5b ÷ (US$125b - US$12b) (Based on the trailing twelve months to March 2020.)
Therefore, Exelon has an ROCE of 4.0%.
Is Exelon's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Exelon's ROCE is around the 4.7% average reported by the Electric Utilities industry. Independently of how Exelon compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.2% available in government bonds. Readers may wish to look for more rewarding investments.
You can click on the image below to see (in greater detail) how Exelon's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Exelon.
What Are Current Liabilities, And How Do They Affect Exelon's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Exelon has total assets of US$125b and current liabilities of US$12b. Therefore its current liabilities are equivalent to approximately 9.4% of its total assets. Exelon has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Exelon's ROCE
Nevertheless, there are potentially more attractive companies to invest in. 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.
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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.