Today we are going to look at Ahlada Engineers Limited (NSE:AHLADA) to see whether it might be an attractive investment prospect. 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 up, we’ll look at what ROCE is and how we calculate it. 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.
Understanding 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. 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 Ahlada Engineers:
0.21 = ₹270m ÷ (₹2.1b – ₹782m) (Based on the trailing twelve months to March 2019.)
Therefore, Ahlada Engineers has an ROCE of 21%.
Is Ahlada Engineers’s ROCE Good?
One way to assess ROCE is to compare similar companies. Ahlada Engineers’s ROCE appears to be substantially greater than the 13% average in the Building industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Ahlada Engineers sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. If Ahlada Engineers is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Ahlada Engineers’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Ahlada Engineers has total liabilities of ₹782m and total assets of ₹2.1b. As a result, its current liabilities are equal to approximately 38% of its total assets. With this level of current liabilities, Ahlada Engineers’s ROCE is boosted somewhat.
Our Take On Ahlada Engineers’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Ahlada Engineers 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.