Today we'll evaluate Freeport-McMoRan Inc. (NYSE:FCX) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is 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?
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 Freeport-McMoRan:
0.019 = US$700m ÷ (US$41b - US$3.4b) (Based on the trailing twelve months to September 2019.)
So, Freeport-McMoRan has an ROCE of 1.9%.
Is Freeport-McMoRan's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Freeport-McMoRan's ROCE appears meaningfully below the 9.0% average reported by the Metals and Mining industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Freeport-McMoRan stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
Freeport-McMoRan has an ROCE of 1.9%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can see in the image below how Freeport-McMoRan's ROCE compares to its industry. Click to see more on past growth.
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 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. We note Freeport-McMoRan could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Freeport-McMoRan.
Freeport-McMoRan's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Freeport-McMoRan has total assets of US$41b and current liabilities of US$3.4b. Therefore its current liabilities are equivalent to approximately 8.2% of its total assets. Freeport-McMoRan has a low level of current liabilities, which have a negligible impact on its already low ROCE.
The Bottom Line On Freeport-McMoRan's ROCE
Still, investors could probably find more attractive prospects with better performance out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 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. Thank you for reading.