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What Can We Make Of Silvercorp Metals Inc.’s (TSE:SVM) High Return On Capital?

Simply Wall St

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Today we'll evaluate Silvercorp Metals Inc. (TSE:SVM) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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 Silvercorp Metals:

0.14 = US$61m ÷ (US$481m - US$44m) (Based on the trailing twelve months to December 2018.)

Therefore, Silvercorp Metals has an ROCE of 14%.

View our latest analysis for Silvercorp Metals

Is Silvercorp Metals's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Silvercorp Metals's ROCE is meaningfully better than the 2.3% 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 Silvercorp Metals sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Silvercorp Metals reported an ROCE of 14% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving.

TSX:SVM Past Revenue and Net Income, May 9th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Silvercorp Metals are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Silvercorp Metals.

How Silvercorp Metals's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Silvercorp Metals has total liabilities of US$44m and total assets of US$481m. As a result, its current liabilities are equal to approximately 9.1% of its total assets. Low current liabilities have only a minimal impact on Silvercorp Metals's ROCE, making its decent returns more credible.

The Bottom Line On Silvercorp Metals's ROCE

This is good to see, and while better prospects may exist, Silvercorp Metals seems worth researching further. Silvercorp Metals shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.