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A Close Look At Northern Star Resources Limited’s (ASX:NST) 16% ROCE

Simply Wall St

Today we'll evaluate Northern Star Resources Limited (ASX:NST) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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.'

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 Northern Star Resources:

0.16 = AU$234m ÷ (AU$1.6b - AU$218m) (Based on the trailing twelve months to June 2019.)

So, Northern Star Resources has an ROCE of 16%.

See our latest analysis for Northern Star Resources

Does Northern Star Resources Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Northern Star Resources's ROCE is meaningfully better than the 9.2% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Northern Star Resources sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

We can see that , Northern Star Resources currently has an ROCE of 16%, less than the 41% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Northern Star Resources's ROCE compares to its industry. Click to see more on past growth.

ASX:NST Past Revenue and Net Income, August 27th 2019

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 only a point-in-time measure. Given the industry it operates in, Northern Star Resources 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.

Do Northern Star Resources'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 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.

Northern Star Resources has total liabilities of AU$218m and total assets of AU$1.6b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Northern Star Resources's ROCE

With that in mind, Northern Star Resources's ROCE appears pretty good. Northern Star Resources shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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 editorial-team@simplywallst.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.