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Today we’ll evaluate V-Guard Industries Limited (NSE:VGUARD) 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 up, we’ll look at what ROCE is and how we calculate it. 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 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?
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 V-Guard Industries:
0.22 = ₹2.0b ÷ (₹14b – ₹4.6b) (Based on the trailing twelve months to March 2019.)
Therefore, V-Guard Industries has an ROCE of 22%.
Is V-Guard Industries’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that V-Guard Industries’s ROCE is meaningfully better than the 12% average in the Electrical industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from V-Guard Industries’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
V-Guard Industries’s current ROCE of 22% is lower than 3 years ago, when the company reported a 33% ROCE. Therefore we wonder if the company is facing new headwinds.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for V-Guard Industries.
Do V-Guard Industries’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) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
V-Guard Industries has total liabilities of ₹4.6b and total assets of ₹14b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. V-Guard Industries has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From V-Guard Industries’s ROCE
V-Guard Industries’s ROCE does look good, but the level of current liabilities also contribute to that. V-Guard Industries shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like V-Guard 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.
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 email@example.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.