Latteys Industries Limited (NSE:LATTEYS) Is Employing Capital Very Effectively

Today we’ll look at Latteys Industries Limited (NSE:LATTEYS) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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’.

How Do You Calculate Return On Capital Employed?

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 Latteys Industries:

0.28 = ₹26m ÷ (₹298m – ₹206m) (Based on the trailing twelve months to March 2018.)

So, Latteys Industries has an ROCE of 28%.

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Does Latteys Industries Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Latteys Industries’s ROCE appears to be substantially greater than the 15% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Latteys Industries’s ROCE currently appears to be excellent.

NSEI:LATTEYS Last Perf January 15th 19
NSEI:LATTEYS Last Perf January 15th 19

When considering this metric, keep in mind that it is backwards looking, and 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, after all, simply a snap shot of a single year. You can check if Latteys Industries has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Latteys Industries’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Latteys Industries has total assets of ₹298m and current liabilities of ₹206m. As a result, its current liabilities are equal to approximately 69% of its total assets. Latteys Industries boasts an attractive ROCE, even after considering the boost from high current liabilities.

What We Can Learn From Latteys Industries’s ROCE

So to us, the company is potentially worth investigating further. You might be able to find a better buy than Latteys Industries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Latteys Industries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.