Why You Should Care About Murudeshwar Ceramics Limited’s (NSE:MURUDCERA) Low Return On Capital

Today we are going to look at Murudeshwar Ceramics Limited (NSE:MURUDCERA) 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. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. In the end, ROCE 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’.

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 Murudeshwar Ceramics:

0.061 = ₹226m ÷ (₹4.8b – ₹996m) (Based on the trailing twelve months to September 2018.)

So, Murudeshwar Ceramics has an ROCE of 6.1%.

View our latest analysis for Murudeshwar Ceramics

Is Murudeshwar Ceramics’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Murudeshwar Ceramics’s ROCE is meaningfully below the Building industry average of 14%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Murudeshwar Ceramics stacks up against its industry, its ROCE in absolute terms is quite low (not much higher than a bank account). It is likely that there are more attractive prospects out there.

NSEI:MURUDCERA Last Perf December 19th 18
NSEI:MURUDCERA Last Perf December 19th 18

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Murudeshwar Ceramics has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Murudeshwar Ceramics’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) unfairly boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Murudeshwar Ceramics has total liabilities of ₹996m and total assets of ₹4.8b. As a result, its current liabilities are equal to approximately 21% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Murudeshwar Ceramics’s ROCE

That’s not a bad thing, however Murudeshwar Ceramics has a weak ROCE and may not be an attractive investment. But note: Murudeshwar Ceramics 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).

Of course Murudeshwar Ceramics may not be the best stock to buy. So you may wish to see this free collection of other companies that have 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.