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Today we'll evaluate Gold Resource Corporation (NYSEMKT:GORO) 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. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from 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?
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 Gold Resource:
0.14 = US$18m ÷ (US$150m - US$18m) (Based on the trailing twelve months to December 2018.)
So, Gold Resource has an ROCE of 14%.
Is Gold Resource's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Gold Resource's ROCE is meaningfully better than the 11% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Gold Resource compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. We note Gold Resource could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Gold Resource's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Gold Resource has total assets of US$150m and current liabilities of US$18m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Gold Resource's ROCE
This is good to see, and with a sound ROCE, Gold Resource could be worth a closer look. Gold Resource looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.