Today we’ll look at Medusa Mining Limited (ASX:MML) 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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.
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 Medusa Mining:
0.24 = US$31m ÷ (US$152m – US$21m) (Based on the trailing twelve months to June 2019.)
Therefore, Medusa Mining has an ROCE of 24%.
Is Medusa Mining’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Medusa Mining’s ROCE appears to be substantially greater 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 the industry comparison, in absolute terms, Medusa Mining’s ROCE currently appears to be excellent.
We can see that, Medusa Mining currently has an ROCE of 24% compared to its ROCE 3 years ago, which was 18%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Medusa Mining’s past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Medusa Mining are cyclical businesses. If Medusa Mining is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Medusa Mining’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Medusa Mining has total assets of US$152m and current liabilities of US$21m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Medusa Mining’s ROCE
This is good to see, and with such a high ROCE, Medusa Mining may be worth a closer look. There might be better investments than Medusa Mining 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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