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Today we'll evaluate Intrepid Potash, Inc. (NYSE:IPI) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Intrepid Potash:
0.038 = US$19m ÷ (US$578m - US$87m) (Based on the trailing twelve months to December 2019.)
So, Intrepid Potash has an ROCE of 3.8%.
Is Intrepid Potash's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Intrepid Potash's ROCE appears meaningfully below the 8.9% average reported by the Chemicals industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Intrepid Potash stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Intrepid Potash reported an ROCE of 3.8% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. The image below shows how Intrepid Potash's ROCE compares to its industry, and you can click it to see more detail on its 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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Intrepid Potash.
Do Intrepid Potash's Current Liabilities Skew 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Intrepid Potash has current liabilities of US$87m and total assets of US$578m. As a result, its current liabilities are equal to approximately 15% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
The Bottom Line On Intrepid Potash's ROCE
Intrepid Potash has a poor ROCE, and there may be better investment prospects 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).
I will like Intrepid Potash better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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