Today we are going to look at Vera Synthetic Limited (NSE:VERA) 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. 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 amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
How Do You Calculate Return On Capital Employed?
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 Vera Synthetic:
0.16 = ₹22m ÷ (₹198m – ₹60m) (Based on the trailing twelve months to September 2019.)
So, Vera Synthetic has an ROCE of 16%.
Is Vera Synthetic’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Vera Synthetic’s ROCE is meaningfully higher than the 12% average in the Luxury industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Vera Synthetic sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
The image below shows how Vera Synthetic’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. You can check if Vera Synthetic has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Vera Synthetic’s Current Liabilities Impact 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Vera Synthetic has current liabilities of ₹60m and total assets of ₹198m. As a result, its current liabilities are equal to approximately 30% of its total assets. With this level of current liabilities, Vera Synthetic’s ROCE is boosted somewhat.
What We Can Learn From Vera Synthetic’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Vera Synthetic shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.