Why We Like Havells India Limited’s (NSE:HAVELLS) 22% Return On Capital Employed

Today we are going to look at Havells India Limited (NSE:HAVELLS) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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.’

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 Havells India:

0.22 = ₹9.1b ÷ (₹66b – ₹25b) (Based on the trailing twelve months to March 2018.)

So, Havells India has an ROCE of 22%.

View our latest analysis for Havells India

Is Havells India’s ROCE Good?

One way to assess ROCE is to compare similar companies. Havells India’s ROCE appears to be substantially greater than the 15% average in the Electrical 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. Separate from Havells India’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

NSEI:HAVELLS Last Perf December 24th 18
NSEI:HAVELLS Last Perf December 24th 18

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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Havells India.

Do Havells India’s Current Liabilities Skew 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 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.

Havells India has total assets of ₹66b and current liabilities of ₹25b. As a result, its current liabilities are equal to approximately 38% of its total assets. Havells India has a medium level of current liabilities, which would boost the ROCE.

What We Can Learn From Havells India’s ROCE

Havells India’s ROCE does look good, but the level of current liabilities also contribute to that. While the ROCE is useful information, it is not always predictive. We need to do more work before making a decision. One data point to check is if insiders have bought shares recently.

But note: Havells India may not be the best stock to buy. So take a peek at this free list of interesting companies with 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.