Why Elecon Engineering Company Limited’s (NSE:ELECON) Return On Capital Employed Might Be A Concern

Today we'll evaluate Elecon Engineering Company Limited (NSE:ELECON) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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'.

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:

0.075 = ₹862m ÷ (₹22b - ₹10b) (Based on the trailing twelve months to June 2019.)

So, Elecon Engineering has an ROCE of 7.5%.

Check out our latest analysis for Elecon Engineering

Does Elecon Engineering Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Elecon Engineering's ROCE appears to be significantly below the 13% average in the Electrical industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Elecon Engineering compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. Readers may wish to look for more rewarding investments.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if Elecon Engineering has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Elecon Engineering's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.

Elecon Engineering has total assets of ₹22b and current liabilities of ₹10b. Therefore its current liabilities are equivalent to approximately 47% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Elecon Engineering's ROCE is concerning.

Our Take On Elecon Engineering's ROCE

So researching other companies may be a better use of your time. You might be able to find a better investment than Elecon Engineering. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Elecon Engineering better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.