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Today we'll look at First Quantum Minerals Ltd. (TSE:FM) 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.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
How Do You Calculate Return On Capital Employed?
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 First Quantum Minerals:
0.038 = US$859m ÷ (US$24b - US$1.7b) (Based on the trailing twelve months to March 2019.)
Therefore, First Quantum Minerals has an ROCE of 3.8%.
Is First Quantum Minerals's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. First Quantum Minerals's ROCE appears to be substantially greater than the 2.3% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside First Quantum Minerals's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
Our data shows that First Quantum Minerals currently has an ROCE of 3.8%, compared to its ROCE of 1.5% 3 years ago. This makes us wonder if the company is improving.
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, First Quantum Minerals could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for First Quantum Minerals.
How First Quantum Minerals's Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
First Quantum Minerals has total liabilities of US$1.7b and total assets of US$24b. Therefore its current liabilities are equivalent to approximately 6.9% of its total assets. First Quantum Minerals has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From First Quantum Minerals's ROCE
Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better investment than First Quantum Minerals. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like First Quantum Minerals 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 email@example.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.