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Why You Should Care About DRDGOLD Limited’s (NYSE:DRD) Low Return On Capital

Simply Wall St

Today we'll evaluate DRDGOLD Limited (NYSE:DRD) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 DRDGOLD:

0.033 = SAR119m ÷ (SAR4.1b - SAR458m) (Based on the trailing twelve months to June 2019.)

So, DRDGOLD has an ROCE of 3.3%.

Check out our latest analysis for DRDGOLD

Does DRDGOLD Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, DRDGOLD's ROCE appears to be significantly below the 8.9% average in the Metals and Mining industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how DRDGOLD stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

You can see in the image below how DRDGOLD's ROCE compares to its industry. Click to see more on past growth.

NYSE:DRD Past Revenue and Net Income, October 22nd 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Given the industry it operates in, DRDGOLD could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for DRDGOLD.

DRDGOLD's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

DRDGOLD has total liabilities of SAR458m and total assets of SAR4.1b. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

Our Take On DRDGOLD's ROCE

That's not a bad thing, however DRDGOLD has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than DRDGOLD. 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).

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.