Before I decide whether to buy a company’s shares, I always like to look at two core financial ratios — return on equity and net gearing.
These two ratios provide an indication of how successful a company is at generating profits using shareholders’ funds and debt, and they have a strong influence on dividend payments and share price growth.
Today, I’m going to take a look at FTSE 100 gold miner Randgold Resources (LSE: RRS) (NASDAQ: GOLD.US), to see how attractive it looks on these two measures.
Return on equity
The return a company generates on its shareholders’ funds is known as return on equity, or ROE. Return on equity can be calculated by dividing a company’s annual profit by its equity (ie, the difference between its total assets and its total liabilities) and is expressed as a percentage.
Randgold’s share price has doubled over the last five years, and its dividend has quadrupled, as the company has ramped up production at its African gold mines. These gains have also been reflected in Randgold’s ROE, as we can see:
| Randgold Resources | 2008 | 2009 | 2010 | 2011 | 2012 | Average |
|---|---|---|---|---|---|---|
| ROE | 6.5% | 6.0% | 6.0% | 19.3% | 18.3% | 11.2% |
What about debt?
A key weakness of ROE is that it doesn’t show how much debt a company is using to boost its returns. My preferred way of measuring a company’s debt is by looking at its net gearing — the ratio of net debt to equity.
Randgold has maintained a net cash position for a number of years, so excessive debt isn’t a concern, but how does it compare to two of its largest UK-listed peers?
| Company | Net gearing | 5-year average ROE |
|---|---|---|
| African Barrick Gold | -11.9% | 0.9% |
| Randgold Resources | -9.2% | 11.2% |
| Polymetal International | 39.8% | 25% (3 year avg.) |
Of the three above, Randgold’s combination of growing ROE and net cash is by far the most attractive to me, especially as Randgold claims that it can remain profitable as long as gold prices stay above $1,000/ounce.
Is Randgold Resources a buy?
Randgold’s production is set to rise by up to 75% over the next few years, as its Kibali mine ramps up. However, the falling price of gold means that Randgold’s earnings are expected to drop by around a quarter this year, as the lower gold price filters through to its bottom line.
This means that Randgold’s trailing P/E of 17 equates to a forward P/E of around 23 — which I find slightly ambitious. Although I have no doubt that Randgold will continue to deliver a solid ROE, I think that its shares are fully valued at present, and rate them as a hold.
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> Roland does not own shares in any of the companies mentioned in this article.
