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Here's What Black Hills Corporation's (NYSE:BKH) ROCE Can Tell Us

Today we are going to look at Black Hills Corporation (NYSE:BKH) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding 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.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

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

Or for Black Hills:

0.06 = US$406m ÷ (US$7.6b - US$811m) (Based on the trailing twelve months to December 2019.)

Therefore, Black Hills has an ROCE of 6.0%.

Check out our latest analysis for Black Hills

Does Black Hills Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Black Hills's ROCE is meaningfully better than the 5.0% 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. Setting aside the industry comparison for now, Black Hills'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.

The image below shows how Black Hills's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:BKH Past Revenue and Net Income April 17th 2020
NYSE:BKH Past Revenue and Net Income April 17th 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Black Hills'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. 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.

Black Hills has total assets of US$7.6b and current liabilities of US$811m. Therefore its current liabilities are equivalent to approximately 11% 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 Black Hills's ROCE

If Black Hills continues to earn an uninspiring ROCE, there may be better places to invest. 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).

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.