Yahoo Finance Here's What BHP Group's (ASX:BHP) ROCE Can Tell Us
Today we'll look at BHP Group (ASX:BHP) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 BHP Group:
0.19 = US$16b ÷ (US$101b - US$12b) (Based on the trailing twelve months to June 2019.)
So, BHP Group has an ROCE of 19%.
Check out our latest analysis for BHP Group
Is BHP Group's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that BHP Group's ROCE is meaningfully better than the 8.0% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where BHP Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, BHP Group's ROCE appears to be 19%, compared to 3 years ago, when its ROCE was 4.5%. This makes us think the business might be improving. The image below shows how BHP Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, BHP Group 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 BHP Group.
What Are Current Liabilities, And How Do They Affect BHP Group'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 counter this, investors can check if a company has high current liabilities relative to total assets.
BHP Group has current liabilities of US$12b and total assets of US$101b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On BHP Group's ROCE
With that in mind, BHP Group's ROCE appears pretty good. There might be better investments than BHP Group 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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. Thank you for reading.
