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What Can We Make Of Fortuna Silver Mines Inc.’s (TSE:FVI) High Return On Capital?

Kyle Sanford

Today we are going to look at Fortuna Silver Mines Inc. (TSE:FVI) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Fortuna Silver Mines:

0.15 = US$101m ÷ (US$738m – US$53m) (Based on the trailing twelve months to September 2018.)

Therefore, Fortuna Silver Mines has an ROCE of 15%.

View our latest analysis for Fortuna Silver Mines

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Does Fortuna Silver Mines Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Fortuna Silver Mines’s ROCE appears to be substantially greater than the 2.4% 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. Separate from Fortuna Silver Mines’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

In our analysis, Fortuna Silver Mines’s ROCE appears to be 15%, compared to 3 years ago, when its ROCE was 6.5%. This makes us wonder if the company is improving.

TSX:FVI Last Perf January 31st 19

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Fortuna Silver Mines are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Fortuna Silver Mines.

Do Fortuna Silver Mines’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Fortuna Silver Mines has total liabilities of US$53m and total assets of US$738m. As a result, its current liabilities are equal to approximately 7.2% of its total assets. Low current liabilities have only a minimal impact on Fortuna Silver Mines’s ROCE, making its decent returns more credible.

What We Can Learn From Fortuna Silver Mines’s ROCE

If it is able to keep this up, Fortuna Silver Mines could be attractive. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.