Is Aarvi Encon Limited (NSE:AARVI) Investing Effectively In Its Business?

Today we'll look at Aarvi Encon Limited (NSE:AARVI) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?

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 Aarvi Encon:

0.11 = ₹76m ÷ (₹1.1b - ₹357m) (Based on the trailing twelve months to September 2019.)

So, Aarvi Encon has an ROCE of 11%.

View our latest analysis for Aarvi Encon

Is Aarvi Encon's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Aarvi Encon's ROCE is around the 11% average reported by the Professional Services industry. Aside from the industry comparison, Aarvi Encon's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Aarvi Encon's current ROCE of 11% is lower than its ROCE in the past, which was 19%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Aarvi Encon's ROCE compares to its industry. Click to see more on past growth.

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 only a point-in-time measure. How cyclical is Aarvi Encon? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Aarvi Encon's 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 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.

Aarvi Encon has total liabilities of ₹357m and total assets of ₹1.1b. As a result, its current liabilities are equal to approximately 33% of its total assets. Aarvi Encon's middling level of current liabilities have the effect of boosting its ROCE a bit.

What We Can Learn From Aarvi Encon's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. Of course, you might also be able to find a better stock than Aarvi Encon. So you may wish to see this free collection of other companies that have grown earnings strongly.

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

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.

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. Thank you for reading.