Today we are going to look at Steel Dynamics, Inc. (NASDAQ:STLD) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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 Steel Dynamics:
0.17 = US$1.2b ÷ (US$7.9b - US$1.0b) (Based on the trailing twelve months to September 2019.)
Therefore, Steel Dynamics has an ROCE of 17%.
Does Steel Dynamics Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Steel Dynamics's ROCE is meaningfully higher than the 8.9% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Steel Dynamics's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Steel Dynamics's ROCE appears to be 17%, compared to 3 years ago, when its ROCE was 12%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Steel Dynamics's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Steel Dynamics could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Steel Dynamics.
Do Steel Dynamics'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. 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.
Steel Dynamics has total assets of US$7.9b and current liabilities of US$1.0b. As a result, its current liabilities are equal to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Steel Dynamics's ROCE
Overall, Steel Dynamics has a decent ROCE and could be worthy of further research. Steel Dynamics 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.
Steel Dynamics is not the only stock insiders are buying. So take a peek at this free list of growing companies with 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 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.