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Today we are going to look at Anglo American plc (LON:AAL) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Anglo American:
0.11 = US$5.2b ÷ (US$52b - US$6.8b) (Based on the trailing twelve months to December 2018.)
Therefore, Anglo American has an ROCE of 11%.
Is Anglo American's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Anglo American's ROCE is fairly close to the Metals and Mining industry average of 13%. Separate from Anglo American's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Anglo American currently has an ROCE of 11%, compared to its ROCE of 3.9% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Anglo American's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Anglo American could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Anglo American.
How Anglo American's Current Liabilities Impact 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Anglo American has total liabilities of US$6.8b and total assets of US$52b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Anglo American's ROCE
This is good to see, and with a sound ROCE, Anglo American could be worth a closer look. Anglo American looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.