Today we'll evaluate Silver Lake Resources Limited (ASX:SLR) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. 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.
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. Generally speaking a higher ROCE is better. 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?
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 Silver Lake Resources:
0.033 = AU$17m ÷ (AU$573m - AU$58m) (Based on the trailing twelve months to June 2019.)
Therefore, Silver Lake Resources has an ROCE of 3.3%.
View our latest analysis for Silver Lake Resources
Is Silver Lake Resources's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Silver Lake Resources's ROCE appears meaningfully below the 8.0% average reported by the Metals and Mining industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Silver Lake Resources stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
We can see that, Silver Lake Resources currently has an ROCE of 3.3% compared to its ROCE 3 years ago, which was 2.2%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Silver Lake Resources's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. We note Silver Lake Resources could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Silver Lake Resources.