Today we are going to look at Anglo Asian Mining PLC (LON:AAZ) to see whether it might be an attractive investment prospect. 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.
Firstly, 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 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 Anglo Asian Mining:
0.21 = US$29m ÷ (US$166m - US$29m) (Based on the trailing twelve months to June 2019.)
Therefore, Anglo Asian Mining has an ROCE of 21%.
Does Anglo Asian Mining Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Anglo Asian Mining's ROCE is meaningfully higher than the 13% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Anglo Asian Mining's ROCE currently appears to be excellent.
In our analysis, Anglo Asian Mining's ROCE appears to be 21%, compared to 3 years ago, when its ROCE was 2.4%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Anglo Asian 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Anglo Asian Mining are cyclical businesses. How cyclical is Anglo Asian Mining? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Anglo Asian Mining's Current Liabilities And Their Impact On 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Anglo Asian Mining has total assets of US$166m and current liabilities of US$29m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
The Bottom Line On Anglo Asian Mining's ROCE
With low current liabilities and a high ROCE, Anglo Asian Mining could be worthy of further investigation. Anglo Asian Mining looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.
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