Today we’ll look at ArcelorMittal (AMS:MT) 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. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
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 ArcelorMittal:
0.10 = US$7.0b ÷ (US$91b – US$23b) (Based on the trailing twelve months to December 2018.)
So, ArcelorMittal has an ROCE of 10%.
Is ArcelorMittal’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that ArcelorMittal’s ROCE is fairly close to the Metals and Mining industry average of 10%. Independently of how ArcelorMittal compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, ArcelorMittal currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 0.3%. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 ArcelorMittal are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How ArcelorMittal’s Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
ArcelorMittal has total liabilities of US$23b and total assets of US$91b. As a result, its current liabilities are equal to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On ArcelorMittal’s ROCE
Overall, ArcelorMittal has a decent ROCE and could be worthy of further research. But note: ArcelorMittal may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.