Today we are going to look at Pioneer Embroideries Limited (NSE:PIONEEREMB) to see whether it might be an attractive investment prospect. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Pioneer Embroideries:
0.11 = ₹110m ÷ (₹1.9b – ₹842m) (Based on the trailing twelve months to September 2019.)
Therefore, Pioneer Embroideries has an ROCE of 11%.
Is Pioneer Embroideries’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Pioneer Embroideries’s ROCE is fairly close to the Luxury industry average of 11%. Separate from how Pioneer Embroideries stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
We can see that, Pioneer Embroideries currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 6.1%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Pioneer Embroideries’s ROCE compares to its industry. Click to see more on past growth.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Pioneer Embroideries has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Pioneer Embroideries’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Pioneer Embroideries has total assets of ₹1.9b and current liabilities of ₹842m. As a result, its current liabilities are equal to approximately 45% of its total assets. Pioneer Embroideries’s middling level of current liabilities have the effect of boosting its ROCE a bit.
Our Take On Pioneer Embroideries’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Pioneer Embroideries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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