Today we'll evaluate Wesdome Gold Mines Ltd. (TSE:WDO) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. 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?
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 Wesdome Gold Mines:
0.16 = CA$33m ÷ (CA$239m - CA$28m) (Based on the trailing twelve months to June 2019.)
So, Wesdome Gold Mines has an ROCE of 16%.
View our latest analysis for Wesdome Gold Mines
Is Wesdome Gold Mines's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Wesdome Gold Mines's ROCE appears to be substantially greater than the 3.4% 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 Wesdome Gold Mines's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Wesdome Gold Mines reported an ROCE of 16% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Given the industry it operates in, Wesdome Gold Mines could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Wesdome Gold Mines.
What Are Current Liabilities, And How Do They Affect Wesdome Gold Mines'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. 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.
Wesdome Gold Mines has total assets of CA$239m and current liabilities of CA$28m. As a result, its current liabilities are equal to approximately 12% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Wesdome Gold Mines's ROCE
Overall, Wesdome Gold Mines has a decent ROCE and could be worthy of further research. There might be better investments than Wesdome Gold Mines 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.
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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.