Sierra Metals Inc. (TSE:SMT) Is Employing Capital Very Effectively
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Today we are going to look at Sierra Metals Inc. (TSE:SMT) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 Sierra Metals:
0.20 = US$56m ÷ (US$357m - US$77m) (Based on the trailing twelve months to September 2018.)
So, Sierra Metals has an ROCE of 20%.
Check out our latest analysis for Sierra Metals
Does Sierra Metals Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Sierra Metals's ROCE is meaningfully higher than the 2.3% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Sierra Metals sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Sierra Metals has an ROCE of 20%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Given the industry it operates in, Sierra Metals could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Sierra Metals.
Do Sierra Metals'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Sierra Metals has total liabilities of US$77m and total assets of US$357m. As a result, its current liabilities are equal to approximately 22% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Sierra Metals's ROCE
This is good to see, and with a sound ROCE, Sierra Metals could be worth a closer look. Of course you might be able to find a better stock than Sierra Metals. 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 editorial-team@simplywallst.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.
