Today we'll evaluate Evolution Mining Limited (ASX:EVN) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from 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. 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 Evolution Mining:
0.12 = AU$329m ÷ (AU$3.1b - AU$295m) (Based on the trailing twelve months to June 2019.)
Therefore, Evolution Mining has an ROCE of 12%.
Does Evolution Mining Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Evolution Mining's ROCE appears to be substantially greater than the 8.0% 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. Regardless of where Evolution Mining 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, Evolution Mining currently has an ROCE of 12% compared to its ROCE 3 years ago, which was 9.0%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Evolution Mining's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. Remember that most companies like Evolution Mining are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Evolution Mining.
Evolution Mining's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Evolution Mining has total liabilities of AU$295m and total assets of AU$3.1b. Therefore its current liabilities are equivalent to approximately 9.5% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Evolution Mining earns a sound return on capital employed.
Our Take On Evolution Mining's ROCE
If it is able to keep this up, Evolution Mining could be attractive. There might be better investments than Evolution Mining 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.