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Today we'll evaluate Silver Lake Resources Limited (ASX:SLR) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. 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. 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 Silver Lake Resources:
0.10 = AU$23m ÷ (AU$264m - AU$37m) (Based on the trailing twelve months to December 2018.)
So, Silver Lake Resources has an ROCE of 10%.
Does Silver Lake Resources Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Silver Lake Resources's ROCE is around the 9.5% average reported by the Metals and Mining industry. Setting aside the industry comparison for now, Silver Lake Resources'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.
Silver Lake Resources delivered an ROCE of 10%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Silver Lake Resources are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Silver Lake Resources.
Do Silver Lake Resources'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Silver Lake Resources has total liabilities of AU$37m and total assets of AU$264m. As a result, its current liabilities are equal to approximately 14% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Silver Lake Resources's ROCE
With that in mind, we're not overly impressed with Silver Lake Resources's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Silver Lake Resources. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.