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Why You Should Care About Sandstorm Gold Ltd.’s (TSE:SSL) Low Return On Capital

Simply Wall St

Today we'll evaluate Sandstorm Gold Ltd. (TSE:SSL) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, 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.

Understanding 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Sandstorm Gold:

0.024 = US$14m ÷ (US$601m - US$4.4m) (Based on the trailing twelve months to June 2019.)

Therefore, Sandstorm Gold has an ROCE of 2.4%.

See our latest analysis for Sandstorm Gold

Does Sandstorm Gold Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Sandstorm Gold's ROCE appears to be significantly below the 3.5% average in the Metals and Mining industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Sandstorm Gold compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. Readers may wish to look for more rewarding investments.

Sandstorm Gold reported an ROCE of 2.4% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how Sandstorm Gold's ROCE compares to its industry. Click to see more on past growth.

TSX:SSL Past Revenue and Net Income, October 31st 2019

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. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Sandstorm Gold are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sandstorm Gold.

What Are Current Liabilities, And How Do They Affect Sandstorm Gold's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Sandstorm Gold has total assets of US$601m and current liabilities of US$4.4m. Therefore its current liabilities are equivalent to approximately 0.7% of its total assets. With barely any current liabilities, there is minimal impact on Sandstorm Gold's admittedly low ROCE.

What We Can Learn From Sandstorm Gold's ROCE

Nevertheless, there are potentially more attractive companies to invest in. Of course, you might also be able to find a better stock than Sandstorm Gold. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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 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. Thank you for reading.