Today we'll look at AK Steel Holding Corporation (NYSE:AKS) and reflect on its potential as an investment. 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, 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 measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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.
How Do You Calculate Return On Capital Employed?
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 AK Steel Holding:
0.12 = US$426m ÷ (US$4.7b - US$1.1b) (Based on the trailing twelve months to June 2019.)
Therefore, AK Steel Holding has an ROCE of 12%.
Is AK Steel Holding's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. AK Steel Holding's ROCE appears to be substantially greater than the 9.0% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how AK Steel Holding compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how AK Steel Holding's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. We note AK Steel Holding could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for AK Steel Holding.
Do AK Steel Holding'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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
AK Steel Holding has total assets of US$4.7b and current liabilities of US$1.1b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On AK Steel Holding's ROCE
Overall, AK Steel Holding has a decent ROCE and could be worthy of further research. There might be better investments than AK Steel Holding 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 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.