Should You Worry About Elecon Engineering Company Limited’s (NSE:ELECON) ROCE?

Today we are going to look at Elecon Engineering Company Limited (NSE:ELECON) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. In the end, ROCE is a valuable metric that has its flaws. 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 Elecon Engineering:

0.11 = ₹640m ÷ (₹22b - ₹11b) (Based on the trailing twelve months to September 2018.)

Therefore, Elecon Engineering has an ROCE of 11%.

See our latest analysis for Elecon Engineering

Does Elecon Engineering Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Elecon Engineering's ROCE appears meaningfully below the 15% average reported by the Electrical industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Elecon Engineering stacks up against its industry, its ROCE in absolute terms is mediocre; not much better than the returns on government bonds. Investors may wish to consider higher-performing investments.

It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. You can check if Elecon Engineering has cyclical profits by looking at this freegraph of past earnings, revenue and cash flow.

How Elecon Engineering's Current Liabilities Impact Its 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) unfairly boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Elecon Engineering has total liabilities of ₹11b and total assets of ₹22b. As a result, its current liabilities are equal to approximately 51% of its total assets. Elecon Engineering has a fairly high level of current liabilities, meaningfully impacting its ROCE.

The Bottom Line On Elecon Engineering's ROCE

Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this freelist of companies with modest (or no) debt, trading on a P/E below 20.

Of course Elecon Engineering may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.