Today we’ll evaluate Pearl Global Industries Limited (NSE:PGIL) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
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.
Return On Capital Employed (ROCE): What is it?
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. Ultimately, it is a useful but imperfect metric. 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?
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 Pearl Global Industries:
0.05 = ₹365m ÷ (₹12b – ₹4.7b) (Based on the trailing twelve months to December 2019.)
So, Pearl Global Industries has an ROCE of 5.0%.
Does Pearl Global Industries Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Pearl Global Industries’s ROCE appears to be significantly below the 12% average in the Luxury industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Pearl Global Industries stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
We can see that, Pearl Global Industries currently has an ROCE of 5.0%, less than the 12% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Pearl Global Industries’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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is Pearl Global Industries? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Pearl Global Industries’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Pearl Global Industries has total assets of ₹12b and current liabilities of ₹4.7b. As a result, its current liabilities are equal to approximately 39% of its total assets. Pearl Global Industries has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.
Our Take On Pearl Global Industries’s ROCE
This company may not be the most attractive investment prospect. 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 Pearl Global Industries 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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