Today we'll look at Zimplats Holdings Limited (ASX:ZIM) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

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. 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 Zimplats Holdings:

0.16 = US$215m ÷ (US$1.5b - US$136m) (Based on the trailing twelve months to June 2019.)

Therefore, Zimplats Holdings has an ROCE of 16%.

See our latest analysis for Zimplats Holdings

Is Zimplats Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Zimplats Holdings's ROCE appears to be substantially greater than the 8.0% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Zimplats Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

We can see that, Zimplats Holdings currently has an ROCE of 16% compared to its ROCE 3 years ago, which was 2.7%. This makes us wonder if the company is improving. The image below shows how Zimplats Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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, after all, simply a snap shot of a single year. Given the industry it operates in, Zimplats Holdings could be considered cyclical. If Zimplats Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Zimplats Holdings's Current Liabilities Skew Its 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.

Zimplats Holdings has total assets of US$1.5b and current liabilities of US$136m. Therefore its current liabilities are equivalent to approximately 9.0% of its total assets. Low current liabilities have only a minimal impact on Zimplats Holdings's ROCE, making its decent returns more credible.

Our Take On Zimplats Holdings's ROCE

This is good to see, and while better prospects may exist, Zimplats Holdings seems worth researching further. Zimplats Holdings 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.

I will like Zimplats Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.

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