Today we’ll evaluate Kabra Extrusiontechnik Limited (NSE:KABRAEXTRU) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Ultimately, it is a useful but imperfect metric. 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 Kabra Extrusiontechnik:
0.086 = ₹203m ÷ (₹3.4b – ₹1.0b) (Based on the trailing twelve months to March 2018.)
So, Kabra Extrusiontechnik has an ROCE of 8.6%.
Is Kabra Extrusiontechnik’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Kabra Extrusiontechnik’s ROCE appears to be significantly below the 15% average in the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Kabra Extrusiontechnik stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Kabra Extrusiontechnik’s current ROCE of 8.6% is lower than its ROCE in the past, which was 15%, 3 years ago. So investors might consider if it has had issues recently.
It is important to remember that ROCE shows past performance, and is 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. If Kabra Extrusiontechnik is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Kabra Extrusiontechnik’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 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.
Kabra Extrusiontechnik has total liabilities of ₹1.0b and total assets of ₹3.4b. As a result, its current liabilities are equal to approximately 30% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Kabra Extrusiontechnik’s ROCE is concerning.
The Bottom Line On Kabra Extrusiontechnik’s ROCE
So researching other companies may be a better use of your time. But note: Kabra Extrusiontechnik may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 email@example.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.