Yahoo Finance Are Fortescue Metals Group Limited’s Returns On Capital Worth Investigating?
Today we'll look at Fortescue Metals Group Limited (ASX:FMG) 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 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'.
How Do You Calculate Return On Capital Employed?
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 Fortescue Metals Group:
0.10 = US$1.7b ÷ (US$18b - US$1.5b) (Based on the trailing twelve months to December 2018.)
So, Fortescue Metals Group has an ROCE of 10%.
View our latest analysis for Fortescue Metals Group
Does Fortescue Metals Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that Fortescue Metals Group's ROCE is fairly close to the Metals and Mining industry average of 9.5%. Aside from the industry comparison, Fortescue Metals Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
We can see that , Fortescue Metals Group currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 4.6%. This makes us think the business might be improving. The image below shows how Fortescue Metals Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. We note Fortescue Metals Group could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Fortescue Metals Group's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Fortescue Metals Group has total assets of US$18b and current liabilities of US$1.5b. As a result, its current liabilities are equal to approximately 8.1% of its total assets. Fortescue Metals Group has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On Fortescue Metals Group's ROCE
Based on this information, Fortescue Metals Group appears to be a mediocre business. You might be able to find a better investment than Fortescue Metals Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.
