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Why You Should Like North American Palladium Ltd.’s (TSE:PDL) ROCE

Simply Wall St

Today we are going to look at North American Palladium Ltd. (TSE:PDL) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

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

ROCE measures the 'return' (pre-tax profit) a company generates from 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 North American Palladium:

0.25 = CA$166m ÷ (CA$702m - CA$47m) (Based on the trailing twelve months to June 2019.)

Therefore, North American Palladium has an ROCE of 25%.

View our latest analysis for North American Palladium

Does North American Palladium Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, North American Palladium's ROCE is meaningfully higher than the 2.8% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, North American Palladium's ROCE is currently very good.

North American Palladium reported an ROCE of 25% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how North American Palladium's past growth compares to other companies.

TSX:PDL Past Revenue and Net Income, August 10th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Given the industry it operates in, North American Palladium could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for North American Palladium.

Do North American Palladium's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

North American Palladium has total assets of CA$702m and current liabilities of CA$47m. As a result, its current liabilities are equal to approximately 6.7% of its total assets. Modest current liabilities are not boosting North American Palladium's very nice ROCE.

Our Take On North American Palladium's ROCE

This suggests the company would be worth researching in more depth. There might be better investments than North American Palladium out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like North American Palladium better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.