Today we’ll look at BEML Limited (NSE:BEML) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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 measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.’
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 BEML:
0.063 = ₹1.9b ÷ (₹47b – ₹17b) (Based on the trailing twelve months to March 2018.)
So, BEML has an ROCE of 6.3%.
Is BEML’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see BEML’s ROCE is meaningfully below the Machinery industry average of 15%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside BEML’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
As we can see, BEML currently has an ROCE of 6.3% compared to its ROCE 3 years ago, which was 1.9%. This makes us wonder if the company is improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. You can check if BEML has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
BEML’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
BEML has total liabilities of ₹17b and total assets of ₹47b. As a result, its current liabilities are equal to approximately 36% of its total assets. BEML has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.
Our Take On BEML’s ROCE
There are likely better investments out there. Of course you might be able to find a better stock than BEML. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.