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Here’s why Aperam S.A.’s (AMS:APAM) Returns On Capital Matters So Much

Simply Wall St

Today we'll look at Aperam S.A. (AMS:APAM) and reflect on its potential as an investment. 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. 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. 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'.

So, How Do We Calculate ROCE?

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 Aperam:

0.065 = €200m ÷ (€3.5b - €449m) (Based on the trailing twelve months to September 2019.)

Therefore, Aperam has an ROCE of 6.5%.

See our latest analysis for Aperam

Is Aperam's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Aperam's ROCE appears to be significantly below the 9.3% average in the Metals and Mining industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Aperam's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Aperam's current ROCE of 6.5% is lower than 3 years ago, when the company reported a 8.8% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Aperam's past growth compares to other companies.

ENXTAM:APAM Past Revenue and Net Income, November 10th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. We note Aperam could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Aperam.

Do Aperam's Current Liabilities Skew 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.

Aperam has total liabilities of €449m and total assets of €3.5b. As a result, its current liabilities are equal to approximately 13% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Aperam's ROCE

If Aperam continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Aperam. So you may wish to see this free collection of other companies that have grown earnings strongly.

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