Today we are going to look at First Quantum Minerals Ltd. (TSE:FM) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 First Quantum Minerals:
0.035 = US$792m ÷ (US$25b - US$2.1b) (Based on the trailing twelve months to June 2019.)
Therefore, First Quantum Minerals has an ROCE of 3.5%.
Does First Quantum Minerals Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that First Quantum Minerals's ROCE is fairly close to the Metals and Mining industry average of 3.4%. Independently of how First Quantum Minerals compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. There are potentially more appealing investments elsewhere.
We can see that, First Quantum Minerals currently has an ROCE of 3.5% compared to its ROCE 3 years ago, which was 1.8%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how First Quantum Minerals's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like First Quantum Minerals are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do First Quantum Minerals's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
First Quantum Minerals has total liabilities of US$2.1b and total assets of US$25b. As a result, its current liabilities are equal to approximately 8.3% of its total assets. With barely any current liabilities, there is minimal impact on First Quantum Minerals's admittedly low ROCE.
What We Can Learn From First Quantum Minerals's ROCE
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If you spot an error that warrants correction, please contact the editor at email@example.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.