Here’s why Cementos Bio Bio S.A.’s (SNSE:CEMENTOS) Returns On Capital Matters So Much

Today we’ll evaluate Cementos Bio Bio S.A. (SNSE:CEMENTOS) to determine whether it could have potential as an investment idea. 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. Finally, we’ll look at how its current liabilities affect 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. 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?

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 Cementos Bio Bio:

0.044 = CL$17b ÷ (CL$428b – CL$54b) (Based on the trailing twelve months to September 2019.)

So, Cementos Bio Bio has an ROCE of 4.4%.

See our latest analysis for Cementos Bio Bio

Is Cementos Bio Bio’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Cementos Bio Bio’s ROCE appears to be significantly below the 8.0% average in the Basic Materials industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Cementos Bio Bio’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

We can see that, Cementos Bio Bio currently has an ROCE of 4.4%, less than the 8.8% it reported 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Cementos Bio Bio’s past growth compares to other companies.

SNSE:CEMENTOS Past Revenue and Net Income, March 4th 2020
SNSE:CEMENTOS Past Revenue and Net Income, March 4th 2020

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. ROCE is, after all, simply a snap shot of a single year. If Cementos Bio Bio is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Cementos Bio Bio’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 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.

Cementos Bio Bio has current liabilities of CL$54b and total assets of CL$428b. As a result, its current liabilities are equal to approximately 13% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

The Bottom Line On Cementos Bio Bio’s ROCE

Cementos Bio Bio has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.