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Today we’ll look at Alkane Resources Limited (ASX:ALK) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
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.’
How Do You Calculate Return On Capital Employed?
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 Alkane Resources:
0.15 = AU$30m ÷ (AU$231m – AU$27m) (Based on the trailing twelve months to June 2018.)
Therefore, Alkane Resources has an ROCE of 15%.
Does Alkane Resources Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Alkane Resources’s ROCE appears to be substantially greater than the 11% 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 where Alkane Resources sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Alkane Resources has an ROCE of 15%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.
When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, Alkane Resources could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Alkane Resources’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Alkane Resources has total assets of AU$231m and current liabilities of AU$27m. As a result, its current liabilities are equal to approximately 12% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Alkane Resources’s ROCE
This is good to see, and with a sound ROCE, Alkane Resources could be worth a closer look. But note: Alkane Resources may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.