Here’s why SML Isuzu Limited’s (NSE:SMLISUZU) Returns On Capital Matters So Much

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Today we are going to look at SML Isuzu Limited (NSE:SMLISUZU) 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. Finally, we’ll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 SML Isuzu:

0.07 = ₹404m ÷ (₹11b – ₹5.2b) (Based on the trailing twelve months to March 2019.)

Therefore, SML Isuzu has an ROCE of 7.0%.

See our latest analysis for SML Isuzu

Does SML Isuzu Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, SML Isuzu’s ROCE appears meaningfully below the 15% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how SML Isuzu stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

SML Isuzu’s current ROCE of 7.0% is lower than 3 years ago, when the company reported a 16% ROCE. So investors might consider if it has had issues recently.

NSEI:SMLISUZU Past Revenue and Net Income, May 30th 2019
NSEI:SMLISUZU Past Revenue and Net Income, May 30th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. How cyclical is SML Isuzu? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How SML Isuzu’s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

SML Isuzu has total assets of ₹11b and current liabilities of ₹5.2b. As a result, its current liabilities are equal to approximately 47% of its total assets. With a medium level of current liabilities boosting the ROCE a little, SML Isuzu’s low ROCE is unappealing.

Our Take On SML Isuzu’s ROCE

So researching other companies may be a better use of your time. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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

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.