Today we are going to look at Ramelius Resources Limited (ASX:RMS) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. Ultimately, it is a useful but imperfect metric. 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 Ramelius Resources:
0.14 = AU$52m ÷ (AU$454m - AU$71m) (Based on the trailing twelve months to December 2019.)
So, Ramelius Resources has an ROCE of 14%.
Does Ramelius Resources Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Ramelius Resources's ROCE appears to be substantially greater than the 9.8% 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. Regardless of where Ramelius Resources sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Ramelius Resources currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 8.6%. This makes us think the business might be improving. You can see in the image below how Ramelius Resources's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. Given the industry it operates in, Ramelius Resources could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Ramelius Resources.
Do Ramelius 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Ramelius Resources has current liabilities of AU$71m and total assets of AU$454m. As a result, its current liabilities are equal to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Ramelius Resources's ROCE
This is good to see, and with a sound ROCE, Ramelius Resources could be worth a closer look. There might be better investments than Ramelius Resources out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.