What Can We Make Of Greaves Cotton Limited’s (NSE:GREAVESCOT) High Return On Capital?

Today we are going to look at Greaves Cotton Limited (NSE:GREAVESCOT) 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, we’ll go over how we 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.

Return On Capital Employed (ROCE): What is it?

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. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 Greaves Cotton:

0.21 = ₹2.1b ÷ (₹13b – ₹3.5b) (Based on the trailing twelve months to March 2018.)

Therefore, Greaves Cotton has an ROCE of 21%.

Check out our latest analysis for Greaves Cotton

Is Greaves Cotton’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Greaves Cotton’s ROCE appears to be substantially greater than the 15% average in the Machinery industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Greaves Cotton compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

NSEI:GREAVESCOT Past Revenue and Net Income, April 26th 2019
NSEI:GREAVESCOT Past Revenue and Net Income, April 26th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Greaves Cotton.

Greaves Cotton’s Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Greaves Cotton has total liabilities of ₹3.5b and total assets of ₹13b. As a result, its current liabilities are equal to approximately 26% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Greaves Cotton’s ROCE

With that in mind, Greaves Cotton’s ROCE appears pretty good. Greaves Cotton 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.