A Close Look At Largo Resources Ltd.’s (TSE:LGO) 32% ROCE

Today we'll evaluate Largo Resources Ltd. (TSE:LGO) to determine whether it could have potential as an investment idea. 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.

Firstly, we'll go over how we 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?

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 Largo Resources:

0.32 = CA$113m ÷ (CA$449m - CA$96m) (Based on the trailing twelve months to September 2019.)

So, Largo Resources has an ROCE of 32%.

See our latest analysis for Largo Resources

Is Largo Resources's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Largo Resources's ROCE appears to be substantially greater than the 3.0% 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. Regardless of the industry comparison, in absolute terms, Largo Resources's ROCE currently appears to be excellent.

Largo Resources delivered an ROCE of 32%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how Largo Resources's ROCE compares to its industry. Click to see more on past growth.

TSX:LGO Past Revenue and Net Income, January 6th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. We note Largo Resources 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.

How Largo Resources'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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Largo Resources has total liabilities of CA$96m and total assets of CA$449m. As a result, its current liabilities are equal to approximately 21% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

Our Take On Largo Resources's ROCE

This is good to see, and with such a high ROCE, Largo Resources may be worth a closer look. There might be better investments than Largo Resources 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.

Largo Resources is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.

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.

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