Today we’ll look at Intrepid Potash, Inc. (NYSE:IPI) and reflect on its potential as an investment. 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. Then we’ll compare its ROCE to similar companies. 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. 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’.
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 Intrepid Potash:
0.055 = US$27m ÷ (US$568m – US$79m) (Based on the trailing twelve months to June 2019.)
So, Intrepid Potash has an ROCE of 5.5%.
Is Intrepid Potash’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Intrepid Potash’s ROCE appears to be significantly below the 10% average in the Chemicals industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Intrepid Potash’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.
Intrepid Potash delivered an ROCE of 5.5%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. The image below shows how Intrepid Potash’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Intrepid Potash.
What Are Current Liabilities, And How Do They Affect Intrepid Potash’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Intrepid Potash has total assets of US$568m and current liabilities of US$79m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On Intrepid Potash’s ROCE
Intrepid Potash has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Intrepid Potash. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.