A Close Look At Fortuna Silver Mines Inc.’s (TSE:FVI) 9.3% ROCE

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Today we’ll look at Fortuna Silver Mines Inc. (TSE:FVI) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. 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’.

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 Fortuna Silver Mines:

0.093 = US$68m ÷ (US$787m – US$61m) (Based on the trailing twelve months to December 2018.)

So, Fortuna Silver Mines has an ROCE of 9.3%.

Check out our latest analysis for Fortuna Silver Mines

Does Fortuna Silver Mines Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Fortuna Silver Mines’s ROCE is meaningfully higher than the 2.4% 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. Separate from how Fortuna Silver Mines stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

In our analysis, Fortuna Silver Mines’s ROCE appears to be 9.3%, compared to 3 years ago, when its ROCE was 2.8%. This makes us think the business might be improving.

TSX:FVI Past Revenue and Net Income, May 2nd 2019
TSX:FVI Past Revenue and Net Income, May 2nd 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Fortuna Silver Mines 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 Fortuna Silver Mines.

Do Fortuna Silver Mines’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Fortuna Silver Mines has total assets of US$787m and current liabilities of US$61m. As a result, its current liabilities are equal to approximately 7.8% of its total assets. With low levels of current liabilities, at least Fortuna Silver Mines’s mediocre ROCE is not unduly boosted.

What We Can Learn From Fortuna Silver Mines’s ROCE

Based on this information, Fortuna Silver Mines appears to be a mediocre business. Of course, you might also be able to find a better stock than Fortuna Silver Mines. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Fortuna Silver Mines better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.