In This Article:
Today we are going to look at Yancoal Australia Ltd (ASX:YAL) 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.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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?
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 Yancoal Australia:
0.11 = AU$966m ÷ (AU$11b - AU$2.1b) (Based on the trailing twelve months to December 2019.)
Therefore, Yancoal Australia has an ROCE of 11%.
See our latest analysis for Yancoal Australia
Does Yancoal Australia Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Yancoal Australia's ROCE is meaningfully higher than the 6.6% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Yancoal Australia's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Yancoal Australia delivered an ROCE of 11%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. The image below shows how Yancoal Australia'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Yancoal Australia 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 Yancoal Australia.