Johnson Controls-Hitachi Air Conditioning India Limited (NSE:JCHAC) Earns A Nice Return On Capital Employed

Today we are going to look at Johnson Controls-Hitachi Air Conditioning India Limited (NSE:JCHAC) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Johnson Controls-Hitachi Air Conditioning India:

0.23 = ₹1.8b ÷ (₹12b - ₹4.6b) (Based on the trailing twelve months to December 2019.)

So, Johnson Controls-Hitachi Air Conditioning India has an ROCE of 23%.

View our latest analysis for Johnson Controls-Hitachi Air Conditioning India

Is Johnson Controls-Hitachi Air Conditioning India's ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Johnson Controls-Hitachi Air Conditioning India's ROCE is meaningfully higher than the 14% average in the Consumer Durables industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Johnson Controls-Hitachi Air Conditioning 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 see in the image below how Johnson Controls-Hitachi Air Conditioning India's ROCE compares to its industry. Click to see more on past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Johnson Controls-Hitachi Air Conditioning India has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Johnson Controls-Hitachi Air Conditioning India's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Johnson Controls-Hitachi Air Conditioning India has total assets of ₹12b and current liabilities of ₹4.6b. Therefore its current liabilities are equivalent to approximately 37% of its total assets. Johnson Controls-Hitachi Air Conditioning India has a medium level of current liabilities, which would boost the ROCE.

What We Can Learn From Johnson Controls-Hitachi Air Conditioning 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. Johnson Controls-Hitachi Air Conditioning 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.