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Should You Like Schnitzer Steel Industries, Inc.’s (NASDAQ:SCHN) High Return On Capital Employed?

Andrew Carroll

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Today we are going to look at Schnitzer Steel Industries, Inc. (NASDAQ:SCHN) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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’.

How Do You Calculate Return On Capital Employed?

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 Schnitzer Steel Industries:

0.16 = US$145m ÷ (US$1.1b – US$194m) (Based on the trailing twelve months to November 2018.)

So, Schnitzer Steel Industries has an ROCE of 16%.

View our latest analysis for Schnitzer Steel Industries

Does Schnitzer Steel Industries Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Schnitzer Steel Industries’s ROCE is meaningfully better than the 11% 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. Independently of how Schnitzer Steel Industries compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Schnitzer Steel Industries has an ROCE of 16%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.

NASDAQGS:SCHN Last Perf February 11th 19

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, Schnitzer Steel Industries could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Schnitzer Steel Industries.

Do Schnitzer Steel Industries’s Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Schnitzer Steel Industries has total assets of US$1.1b and current liabilities of US$194m. As a result, its current liabilities are equal to approximately 17% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From Schnitzer Steel Industries’s ROCE

Overall, Schnitzer Steel Industries has a decent ROCE and could be worthy of further research. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Schnitzer Steel Industries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.