Today we are going to look at Aurelia Metals Limited (ASX:AMI) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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'.
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 Aurelia Metals:
0.20 = AU$53m ÷ (AU$321m - AU$52m) (Based on the trailing twelve months to June 2019.)
Therefore, Aurelia Metals has an ROCE of 20%.
Does Aurelia Metals Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Aurelia Metals's ROCE appears to be substantially greater than the 8.0% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Aurelia Metals's ROCE currently appears to be excellent.
We can see that, Aurelia Metals currently has an ROCE of 20% compared to its ROCE 3 years ago, which was 6.7%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Aurelia Metals's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Given the industry it operates in, Aurelia Metals could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Aurelia Metals's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Aurelia Metals has total assets of AU$321m and current liabilities of AU$52m. As a result, its current liabilities are equal to approximately 16% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
Our Take On Aurelia Metals's ROCE
Low current liabilities and high ROCE is a good combination, making Aurelia Metals look quite interesting. There might be better investments than Aurelia Metals out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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.
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