Today we'll evaluate Orocobre Limited (ASX:ORE) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Orocobre:
0.0043 = US$4.3m ÷ (US$1.1b - US$111m) (Based on the trailing twelve months to June 2019.)
Therefore, Orocobre has an ROCE of 0.4%.
Does Orocobre Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Orocobre's ROCE is meaningfully below the Metals and Mining industry average of 8.0%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Orocobre's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Orocobre reported an ROCE of 0.4% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can see in the image below how Orocobre's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Orocobre are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Orocobre.
What Are Current Liabilities, And How Do They Affect Orocobre's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Orocobre has total liabilities of US$111m and total assets of US$1.1b. Therefore its current liabilities are equivalent to approximately 10.0% of its total assets. Orocobre has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From Orocobre's ROCE
Nevertheless, there are potentially more attractive companies to invest in. 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.
Orocobre 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 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.