Today we are going to look at India Nippon Electricals Limited (NSE:INDNIPPON) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for India Nippon Electricals:
0.17 = ₹689m ÷ (₹5.1b – ₹1.0b) (Based on the trailing twelve months to June 2019.)
So, India Nippon Electricals has an ROCE of 17%.
Does India Nippon Electricals Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see India Nippon Electricals’s ROCE is around the 15% average reported by the Auto Components industry. Regardless of where India Nippon Electricals 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, India Nippon Electricals currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 12%. This makes us think about whether the company has been reinvesting shrewdly. Take a look at the image below to see how India Nippon Electricals’s past growth compares to the average in its industry.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for India Nippon Electricals.
India Nippon Electricals’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. 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.
India Nippon Electricals has total assets of ₹5.1b and current liabilities of ₹1.0b. Therefore its current liabilities are equivalent to approximately 20% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From India Nippon Electricals’s ROCE
With that in mind, India Nippon Electricals’s ROCE appears pretty good. There might be better investments than India Nippon Electricals 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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.