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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. 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. Generally speaking a higher ROCE is better. 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?
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 Cleveland-Cliffs:
0.21 = US$625m ÷ (US$3.4b - US$437m) (Based on the trailing twelve months to June 2019.)
Therefore, Cleveland-Cliffs has an ROCE of 21%.
Does Cleveland-Cliffs Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Cleveland-Cliffs's ROCE is meaningfully higher than the 8.9% 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, Cleveland-Cliffs's ROCE currently appears to be excellent.
We can see that , Cleveland-Cliffs currently has an ROCE of 21% compared to its ROCE 3 years ago, which was 9.0%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Cleveland-Cliffs'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. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, Cleveland-Cliffs could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cleveland-Cliffs.
What Are Current Liabilities, And How Do They Affect Cleveland-Cliffs's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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$437m and total assets of US$3.4b. As a result, its current liabilities are equal to approximately 13% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Cleveland-Cliffs's ROCE
This is good to see, and with such a high ROCE, Cleveland-Cliffs may be worth a closer look. There might be better investments than Cleveland-Cliffs 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.