U.S. Markets open in 1 min

Why We Like OceanaGold Corporation’s (TSE:OGC) 7.2% Return On Capital Employed

Simply Wall St

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we are going to look at OceanaGold Corporation (TSE:OGC) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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.'

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 OceanaGold:

0.072 = US$133m ÷ (US$2.0b - US$186m) (Based on the trailing twelve months to March 2019.)

So, OceanaGold has an ROCE of 7.2%.

See our latest analysis for OceanaGold

Is OceanaGold's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. OceanaGold's ROCE appears to be substantially greater than the 2.9% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how OceanaGold stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

The image below shows how OceanaGold's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:OGC Past Revenue and Net Income, June 30th 2019

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. Remember that most companies like OceanaGold are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for OceanaGold.

How OceanaGold's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

OceanaGold has total liabilities of US$186m and total assets of US$2.0b. Therefore its current liabilities are equivalent to approximately 9.2% of its total assets. With low levels of current liabilities, at least OceanaGold's mediocre ROCE is not unduly boosted.

Our Take On OceanaGold's ROCE

If performance improves, then OceanaGold may be an OK investment, especially at the right valuation. Of course, you might also be able to find a better stock than OceanaGold. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.