In This Article:
Today we are going to look at Champion Iron Limited (ASX:CIA) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 Champion Iron:
0.59 = CA$386m ÷ (CA$799m - CA$147m) (Based on the trailing twelve months to June 2019.)
Therefore, Champion Iron has an ROCE of 59%.
See our latest analysis for Champion Iron
Does Champion Iron Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Champion Iron's ROCE is meaningfully better than the 9.1% 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, Champion Iron's ROCE currently appears to be excellent.
Champion Iron reported an ROCE of 59% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Champion Iron's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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 Champion Iron could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Champion Iron.