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Today we'll evaluate Teck Resources Limited (TSE:TECK.B) to determine whether it could have potential as an investment idea. 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. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Teck Resources:
0.089 = CA$3.5b ÷ (CA$42b - CA$2.3b) (Based on the trailing twelve months to March 2019.)
So, Teck Resources has an ROCE of 8.9%.
Is Teck Resources's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Teck Resources's ROCE appears to be substantially greater than the 2.8% 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. Aside from the industry comparison, Teck Resources's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Teck Resources delivered an ROCE of 8.9%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
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 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, Teck Resources could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Teck Resources.
How Teck Resources's Current Liabilities Impact 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.
Teck Resources has total liabilities of CA$2.3b and total assets of CA$42b. As a result, its current liabilities are equal to approximately 5.5% of its total assets. Teck Resources reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Teck Resources's ROCE
Based on this information, Teck Resources appears to be a mediocre business. You might be able to find a better investment than Teck 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).
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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 email@example.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.