Today we'll evaluate Mongolian Mining Corporation (HKG:975) 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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?
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 Mongolian Mining:
0.11 = US$154m ÷ (US$1.7b - US$235m) (Based on the trailing twelve months to June 2019.)
Therefore, Mongolian Mining has an ROCE of 11%.
Does Mongolian Mining Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Mongolian Mining's ROCE appears to be substantially greater than the 7.8% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Mongolian Mining sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Mongolian Mining delivered an ROCE of 11%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. The image below shows how Mongolian Mining's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is only a point-in-time measure. Given the industry it operates in, Mongolian Mining could be considered cyclical. If Mongolian Mining is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Mongolian Mining's Current Liabilities Impact Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Mongolian Mining has total assets of US$1.7b and current liabilities of US$235m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Mongolian Mining's ROCE
This is good to see, and with a sound ROCE, Mongolian Mining could be worth a closer look. There might be better investments than Mongolian Mining 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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