Technofab Engineering Limited’s (NSE:TECHNOFAB) Investment Returns Are Lagging Its Industry

Today we'll evaluate Technofab Engineering Limited (NSE:TECHNOFAB) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. 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. Generally speaking a higher ROCE is better. In brief, ROCE is a useful tool, but it is not without drawbacks. 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?

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 Technofab Engineering:

0.13 = ₹494m ÷ (₹7.0b - ₹3.1b) (Based on the trailing twelve months to March 2018.)

Therefore, Technofab Engineering has an ROCE of 13%.

View our latest analysis for Technofab Engineering

Is Technofab Engineering's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Technofab Engineering's ROCE is around the 12% average reported by the Construction industry. Setting aside the industry comparison for now, Technofab Engineering's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

As we can see, Technofab Engineering currently has an ROCE of 13% compared to its ROCE 3 years ago, which was 9.1%. This makes us think the business might be improving.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. How cyclical is Technofab Engineering? You can see for yourself by looking at this freegraph of past earnings, revenue and cash flow.

How Technofab Engineering's Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.

Technofab Engineering has total assets of ₹7.0b and current liabilities of ₹3.1b. As a result, its current liabilities are equal to approximately 45% of its total assets. Technofab Engineering has a medium level of current liabilities, which would boost its ROCE somewhat.

What We Can Learn From Technofab Engineering's ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course you might be able to find a better stock than Technofab Engineering. So you may wish to see this freecollection of other companies that have grown earnings strongly.

But note: Technofab Engineering may not be the best stock to buy. So take a peek at this free list of interesting companies with 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.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.