Why You Should Care About Patel Engineering Limited’s (NSE:PATELENG) Low Return On Capital

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Today we'll evaluate Patel Engineering Limited (NSE:PATELENG) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. 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?

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 Patel Engineering:

0.069 = ₹3.0b ÷ (₹82b - ₹38b) (Based on the trailing twelve months to March 2019.)

Therefore, Patel Engineering has an ROCE of 6.9%.

View our latest analysis for Patel Engineering

Is Patel Engineering's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Patel Engineering's ROCE is meaningfully below the Construction industry average of 12%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Patel Engineering compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. It is likely that there are more attractive prospects out there.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. If Patel Engineering is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Patel Engineering's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Patel Engineering has total assets of ₹82b and current liabilities of ₹38b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Patel Engineering's low ROCE is unappealing.

The Bottom Line On Patel Engineering's ROCE

So researching other companies may be a better use of your time. You might be able to find a better investment than Patel Engineering. 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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 editorial-team@simplywallst.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.