Should You Like L&T Technology Services Limited’s (NSE:LTTS) High Return On Capital Employed?

Today we'll look at L&T Technology Services Limited (NSE:LTTS) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'

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 L&T Technology Services:

0.30 = ₹9.0b ÷ (₹40b - ₹9.5b) (Based on the trailing twelve months to June 2019.)

Therefore, L&T Technology Services has an ROCE of 30%.

Check out our latest analysis for L&T Technology Services

Is L&T Technology Services's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that L&T Technology Services's ROCE is meaningfully better than the 14% average in the Professional Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, L&T Technology Services's ROCE in absolute terms currently looks quite high.

We can see that , L&T Technology Services currently has an ROCE of 30%, less than the 43% it reported 3 years ago. This makes us wonder if the business is facing new challenges.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do L&T Technology Services'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.

L&T Technology Services has total liabilities of ₹9.5b and total assets of ₹40b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.

The Bottom Line On L&T Technology Services's ROCE

Low current liabilities and high ROCE is a good combination, making L&T Technology Services look quite interesting. There might be better investments than L&T Technology Services out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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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.