Today we’ll evaluate Shakti Pumps (India) Limited (NSE:SHAKTIPUMP) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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 Shakti Pumps (India):
0.17 = ₹561m ÷ (₹5.5b – ₹2.2b) (Based on the trailing twelve months to September 2019.)
Therefore, Shakti Pumps (India) has an ROCE of 17%.
Is Shakti Pumps (India)’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Shakti Pumps (India)’s ROCE is meaningfully higher than the 13% average in the Machinery 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. Separate from Shakti Pumps (India)’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how Shakti Pumps (India)’s past growth compares to other companies.
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 Shakti Pumps (India) 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 Shakti Pumps (India)’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Shakti Pumps (India) has total liabilities of ₹2.2b and total assets of ₹5.5b. As a result, its current liabilities are equal to approximately 40% of its total assets. Shakti Pumps (India) has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Shakti Pumps (India)’s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Shakti Pumps (India) looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
Shakti Pumps (India) is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider 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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