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Today we are going to look at Cleveland-Cliffs Inc. (NYSE:CLF) 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.
First up, we’ll look at what ROCE is and how we calculate it. 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.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. 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 Cleveland-Cliffs:
0.23 = US$689m ÷ (US$3.5b – US$468m) (Based on the trailing twelve months to December 2018.)
Therefore, Cleveland-Cliffs has an ROCE of 23%.
Does Cleveland-Cliffs Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Cleveland-Cliffs’s ROCE appears to be substantially greater than the 11% average in the Metals and Mining 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 comparison to its industry for a moment, Cleveland-Cliffs’s ROCE in absolute terms currently looks quite high.
As we can see, Cleveland-Cliffs currently has an ROCE of 23% compared to its ROCE 3 years ago, which was 8.4%. This makes us wonder if the company is improving.
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. ROCE is only a point-in-time measure. Given the industry it operates in, Cleveland-Cliffs 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.
How Cleveland-Cliffs’s Current Liabilities Impact 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.
Cleveland-Cliffs has total liabilities of US$468m and total assets of US$3.5b. As a result, its current liabilities are equal to approximately 13% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
The Bottom Line On Cleveland-Cliffs’s ROCE
With low current liabilities and a high ROCE, Cleveland-Cliffs could be worthy of further investigation. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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 firstname.lastname@example.org. 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.