Today we are going to look at Hercules Hoists Limited (NSE:HERCULES) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is 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. Generally speaking a higher ROCE is better. 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 Hercules Hoists:
0.016 = ₹71m ÷ (₹4.5b – ₹163m) (Based on the trailing twelve months to June 2019.)
So, Hercules Hoists has an ROCE of 1.6%.
Does Hercules Hoists Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Hercules Hoists’s ROCE appears meaningfully below the 13% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Hercules Hoists stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
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. If Hercules Hoists is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Hercules Hoists’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Hercules Hoists has total liabilities of ₹163m and total assets of ₹4.5b. Therefore its current liabilities are equivalent to approximately 3.6% of its total assets. Hercules Hoists has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Hercules Hoists’s ROCE
Still, investors could probably find more attractive prospects with better performance out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.