Today we’ll look at Usha Martin Limited (NSE:USHAMART) and reflect on its potential as an investment. 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. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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 Usha Martin:
0.15 = ₹2.4b ÷ (₹27b – ₹11b) (Based on the trailing twelve months to December 2019.)
Therefore, Usha Martin has an ROCE of 15%.
Is Usha Martin’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Usha Martin’s ROCE appears to be around the 14% average of the Metals and Mining industry. Regardless of where Usha Martin sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Usha Martin currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 3.7%. This makes us think the business might be improving. The image below shows how Usha Martin’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. Given the industry it operates in, Usha Martin could be considered cyclical. How cyclical is Usha Martin? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Usha Martin’s Current Liabilities And Their Impact On Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Usha Martin has current liabilities of ₹11b and total assets of ₹27b. As a result, its current liabilities are equal to approximately 39% of its total assets. Usha Martin has a medium level of current liabilities, which would boost the ROCE.
Our Take On Usha Martin’s ROCE
Usha Martin’s ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than Usha Martin 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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