Today we'll evaluate Silver Lake Resources Limited (ASX:SLR) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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. 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. 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 Silver Lake Resources:
0.033 = AU$17m ÷ (AU$573m - AU$58m) (Based on the trailing twelve months to June 2019.)
Therefore, Silver Lake Resources has an ROCE of 3.3%.
Is Silver Lake Resources's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Silver Lake Resources's ROCE appears meaningfully below the 8.0% average reported by the Metals and Mining industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Silver Lake Resources stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
We can see that, Silver Lake Resources currently has an ROCE of 3.3% compared to its ROCE 3 years ago, which was 2.2%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Silver Lake Resources's past growth compares to other companies.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. We note Silver Lake Resources could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Silver Lake Resources.
What Are Current Liabilities, And How Do They Affect Silver Lake Resources's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Silver Lake Resources has total assets of AU$573m and current liabilities of AU$58m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Silver Lake Resources's ROCE
Silver Lake Resources has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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