Today we’ll evaluate H.G. Infra Engineering Limited (NSE:HGINFRA) to determine whether it could have potential as an investment idea. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it 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?
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 H.G. Infra Engineering:
0.29 = ₹2.6b ÷ (₹18b – ₹8.8b) (Based on the trailing twelve months to September 2019.)
Therefore, H.G. Infra Engineering has an ROCE of 29%.
Is H.G. Infra Engineering’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. H.G. Infra Engineering’s ROCE appears to be substantially greater than the 14% average in the Construction 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. Setting aside the comparison to its industry for a moment, H.G. Infra Engineering’s ROCE in absolute terms currently looks quite high.
You can see in the image below how H.G. Infra Engineering’s ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for H.G. Infra Engineering.
What Are Current Liabilities, And How Do They Affect H.G. Infra Engineering’s 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.
H.G. Infra Engineering has total assets of ₹18b and current liabilities of ₹8.8b. As a result, its current liabilities are equal to approximately 50% of its total assets. H.G. Infra Engineering’s ROCE is boosted somewhat by its middling amount of current liabilities.
What We Can Learn From H.G. Infra Engineering’s ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than H.G. Infra Engineering out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like H.G. Infra 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.
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.
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