Yahoo Finance Why Ikwezi Mining Limited’s (ASX:IKW) Return On Capital Employed Looks Uninspiring
Today we'll evaluate Ikwezi Mining Limited (ASX:IKW) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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'.
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 Ikwezi Mining:
0.053 = AU$1.2m ÷ (AU$24m - AU$1.2m) (Based on the trailing twelve months to June 2019.)
Therefore, Ikwezi Mining has an ROCE of 5.3%.
View our latest analysis for Ikwezi Mining
Is Ikwezi Mining's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Ikwezi Mining's ROCE appears meaningfully below the 13% average reported by the Oil and Gas industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Ikwezi Mining's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Ikwezi Mining reported an ROCE of 5.3% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. The image below shows how Ikwezi Mining'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 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. Remember that most companies like Ikwezi Mining are cyclical businesses. You can check if Ikwezi Mining has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Ikwezi Mining's Current Liabilities Impact 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 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.
Ikwezi Mining has total liabilities of AU$1.2m and total assets of AU$24m. Therefore its current liabilities are equivalent to approximately 5.0% of its total assets. Ikwezi Mining reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Ikwezi Mining's ROCE
Based on this information, Ikwezi Mining appears to be a mediocre business. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
