Today we’ll look at V-Guard Industries Limited (NSE:VGUARD) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 V-Guard Industries:
0.22 = ₹1.7b ÷ (₹12b – ₹4.0b) (Based on the trailing twelve months to March 2018.)
Therefore, V-Guard Industries has an ROCE of 22%.
Is V-Guard Industries’s ROCE Good?
One way to assess ROCE is to compare similar companies. V-Guard Industries’s ROCE appears to be substantially greater than the 15% average in the Electrical industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how V-Guard Industries compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for V-Guard Industries.
Do V-Guard Industries’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 assets of ₹12b and current liabilities of ₹4.0b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. With this level of current liabilities, V-Guard Industries’s ROCE is boosted somewhat.
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. Of course you might be able to find a better stock than V-Guard Industries. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 firstname.lastname@example.org. 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.