Should You Like A2A S.p.A.’s (BIT:A2A) High Return On Capital Employed?
Today we'll evaluate A2A S.p.A. (BIT:A2A) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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.
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 A2A:
0.087 = €705m ÷ (€11b - €2.6b) (Based on the trailing twelve months to December 2019.)
So, A2A has an ROCE of 8.7%.
View our latest analysis for A2A
Does A2A Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, A2A's ROCE is meaningfully higher than the 5.0% average in the Integrated Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the industry comparison for now, A2A's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how A2A's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for A2A.
Do A2A's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
A2A has current liabilities of €2.6b and total assets of €11b. Therefore its current liabilities are equivalent to approximately 25% 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 A2A's ROCE
That said, A2A's ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like A2A 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.
