Today we are going to look at American Water Works Company, Inc. (NYSE:AWK) to see whether it might be an attractive investment prospect. 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. 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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'.

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 American Water Works Company:

0.057 = US$1.2b ÷ (US$22b - US$1.5b) (Based on the trailing twelve months to September 2019.)

Therefore, American Water Works Company has an ROCE of 5.7%.

Check out our latest analysis for American Water Works Company

Does American Water Works Company Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that American Water Works Company's ROCE is meaningfully better than the 4.3% average in the Water Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Aside from the industry comparison, American Water Works Company's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

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

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. 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.

American Water Works Company's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

American Water Works Company has total assets of US$22b and current liabilities of US$1.5b. As a result, its current liabilities are equal to approximately 6.7% of its total assets. American Water Works Company reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

What We Can Learn From American Water Works Company's ROCE

If performance improves, then American Water Works Company may be an OK investment, especially at the right valuation. You might be able to find a better investment than American Water Works Company. 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.