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Why Newcrest Mining Limited’s (ASX:NCM) Use Of Investor Capital Doesn’t Look Great

Today we'll look at Newcrest Mining Limited (ASX:NCM) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Newcrest Mining:

0.058 = US$621m ÷ (US$11b - US$637m) (Based on the trailing twelve months to December 2018.)

So, Newcrest Mining has an ROCE of 5.8%.

View our latest analysis for Newcrest Mining

Is Newcrest Mining's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Newcrest Mining's ROCE is meaningfully below the Metals and Mining industry average of 9.5%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Newcrest Mining'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.

You can click on the image below to see (in greater detail) how Newcrest Mining's past growth compares to other companies.

ASX:NCM Past Revenue and Net Income, July 31st 2019
ASX:NCM Past Revenue and Net Income, July 31st 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. Given the industry it operates in, Newcrest Mining could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Newcrest Mining.

Newcrest 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Newcrest Mining has total assets of US$11b and current liabilities of US$637m. Therefore its current liabilities are equivalent to approximately 5.6% of its total assets. With low levels of current liabilities, at least Newcrest Mining's mediocre ROCE is not unduly boosted.

Our Take On Newcrest Mining's ROCE

If performance improves, then Newcrest Mining may be an OK investment, especially at the right valuation. Of course, you might also be able to find a better stock than Newcrest Mining. So you may wish to see this free collection of other companies that have grown earnings strongly.

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

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.