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Today we are going to look at Mineral Resources Limited (ASX:MIN) 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 of all, we'll work out how to 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 amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Mineral Resources:
0.11 = AU$248m ÷ (AU$2.6b - AU$372m) (Based on the trailing twelve months to December 2018.)
Therefore, Mineral Resources has an ROCE of 11%.
Is Mineral Resources's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Mineral Resources's ROCE is around the 9.5% average reported by the Metals and Mining industry. Regardless of where Mineral Resources sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
The image below shows how Mineral Resources's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is only a point-in-time measure. Remember that most companies like Mineral 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 Mineral Resources.
What Are Current Liabilities, And How Do They Affect Mineral Resources's 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Mineral Resources has total assets of AU$2.6b and current liabilities of AU$372m. As a result, its current liabilities are equal to approximately 14% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Mineral Resources's ROCE
With that in mind, Mineral Resources's ROCE appears pretty good. Mineral Resources looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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 firstname.lastname@example.org. 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.