Today we'll look at Central Asia Metals plc (LON:CAML) and reflect on its potential as an investment. 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. 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 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Central Asia Metals:
0.18 = US$84m ÷ (US$527m - US$52m) (Based on the trailing twelve months to June 2019.)
So, Central Asia Metals has an ROCE of 18%.
Is Central Asia Metals's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Central Asia Metals's ROCE appears to be substantially greater than the 13% average in the Metals and Mining industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Central Asia Metals's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Central Asia Metals's current ROCE of 18% is lower than its ROCE in the past, which was 24%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Central Asia Metals's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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, after all, simply a snap shot of a single year. Remember that most companies like Central Asia Metals are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Central Asia Metals.
Central Asia Metals'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.
Central Asia Metals has total liabilities of US$52m and total assets of US$527m. As a result, its current liabilities are equal to approximately 9.8% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Central Asia Metals earns a sound return on capital employed.
The Bottom Line On Central Asia Metals's ROCE
If Central Asia Metals can continue reinvesting in its business, it could be an attractive prospect. Central Asia 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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. Thank you for reading.