Today we’ll look at Innovana Thinklabs Limited (NSE:INNOVANA) 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. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
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 Innovana Thinklabs:
0.47 = ₹190m ÷ (₹860m – ₹454m) (Based on the trailing twelve months to September 2019.)
Therefore, Innovana Thinklabs has an ROCE of 47%.
Does Innovana Thinklabs Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Innovana Thinklabs’s ROCE is meaningfully higher than the 11% average in the Software industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Innovana Thinklabs’s ROCE is currently very good.
The image below shows how Innovana Thinklabs’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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Innovana Thinklabs has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Innovana Thinklabs’s Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Innovana Thinklabs has total liabilities of ₹454m and total assets of ₹860m. Therefore its current liabilities are equivalent to approximately 53% of its total assets. While a high level of current liabilities boosts its ROCE, Innovana Thinklabs’s returns are still very good.
What We Can Learn From Innovana Thinklabs’s ROCE
In my book, this business could be worthy of further research. There might be better investments than Innovana Thinklabs out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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