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Fortuna Silver Mines Inc. (TSE:FVI) Earns A Nice Return On Capital Employed

Simply Wall St

Today we'll look at Fortuna Silver Mines Inc. (TSE:FVI) and reflect on its potential as an investment. 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.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

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. 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 Fortuna Silver Mines:

0.07 = US$52m ÷ (US$823m - US$81m) (Based on the trailing twelve months to June 2019.)

Therefore, Fortuna Silver Mines has an ROCE of 7.0%.

See our latest analysis for Fortuna Silver Mines

Does Fortuna Silver Mines Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Fortuna Silver Mines's ROCE is meaningfully better than the 3.4% 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. Aside from the industry comparison, Fortuna Silver Mines's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

We can see that, Fortuna Silver Mines currently has an ROCE of 7.0% compared to its ROCE 3 years ago, which was 1.9%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Fortuna Silver Mines's past growth compares to other companies.

TSX:FVI Past Revenue and Net Income, September 30th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Fortuna Silver Mines could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Fortuna Silver Mines.

Fortuna Silver Mines's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

Fortuna Silver Mines has total liabilities of US$81m and total assets of US$823m. As a result, its current liabilities are equal to approximately 9.9% of its total assets. With low levels of current liabilities, at least Fortuna Silver Mines's mediocre ROCE is not unduly boosted.

What We Can Learn From Fortuna Silver Mines's ROCE

Based on this information, Fortuna Silver Mines appears to be a mediocre business. You might be able to find a better investment than Fortuna Silver Mines. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.