Today we are going to look at Ascendant Resources Inc. (TSE:ASND) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared 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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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. 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’.
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 Ascendant Resources:
0.16 = -US$8.1m ÷ (US$67m – US$24m) (Based on the trailing twelve months to September 2018.)
So, Ascendant Resources has an ROCE of 16%.
Does Ascendant Resources Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Ascendant Resources’s ROCE is meaningfully higher than the 2.2% average in the Metals and Mining industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Ascendant Resources compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. We note Ascendant Resources could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ascendant Resources.
How Ascendant 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Ascendant Resources has total assets of US$67m and current liabilities of US$24m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. With this level of current liabilities, Ascendant Resources’s ROCE is boosted somewhat.
The Bottom Line On Ascendant Resources’s ROCE
Ascendant Resources’s ROCE does look good, but the level of current liabilities also contribute to that. Of course you might be able to find a better stock than Ascendant Resources. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.