Today we'll look at Pretium Resources Inc. (TSE:PVG) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Pretium Resources:
0.086 = US$123m ÷ (US$1.6b - US$156m) (Based on the trailing twelve months to September 2019.)
So, Pretium Resources has an ROCE of 8.6%.
Does Pretium Resources Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Pretium Resources's ROCE is meaningfully better than the 3.1% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how Pretium Resources stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Pretium Resources has an ROCE of 8.6%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. The image below shows how Pretium Resources's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. Given the industry it operates in, Pretium Resources 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 Pretium Resources.
Do Pretium Resources'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.
Pretium Resources has total liabilities of US$156m and total assets of US$1.6b. Therefore its current liabilities are equivalent to approximately 9.9% of its total assets. With low levels of current liabilities, at least Pretium Resources's mediocre ROCE is not unduly boosted.
What We Can Learn From Pretium Resources's ROCE
Pretium Resources looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Pretium Resources. 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).
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.
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