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Why We Like Saracen Mineral Holdings Limited’s (ASX:SAR) 22% Return On Capital Employed

Simply Wall St

Today we are going to look at Saracen Mineral Holdings Limited (ASX:SAR) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, 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.

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.

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 Saracen Mineral Holdings:

0.22 = AU$130m ÷ (AU$681m - AU$75m) (Based on the trailing twelve months to June 2019.)

So, Saracen Mineral Holdings has an ROCE of 22%.

See our latest analysis for Saracen Mineral Holdings

Does Saracen Mineral Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Saracen Mineral Holdings's ROCE appears to be substantially greater than the 7.7% average in the Metals and Mining industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Saracen Mineral Holdings's ROCE currently appears to be excellent.

Our data shows that Saracen Mineral Holdings currently has an ROCE of 22%, compared to its ROCE of 12% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Saracen Mineral Holdings's past growth compares to other companies.

ASX:SAR Past Revenue and Net Income, September 24th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. We note Saracen Mineral Holdings 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 Saracen Mineral Holdings'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Saracen Mineral Holdings has total assets of AU$681m and current liabilities of AU$75m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

The Bottom Line On Saracen Mineral Holdings's ROCE

Low current liabilities and high ROCE is a good combination, making Saracen Mineral Holdings look quite interesting. Saracen Mineral Holdings 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.

I will like Saracen Mineral Holdings 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.