Today we'll look at Century Enka Limited (NSE:CENTENKA) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 Century Enka:
0.089 = ₹983m ÷ (₹12b - ₹1.3b) (Based on the trailing twelve months to June 2019.)
So, Century Enka has an ROCE of 8.9%.
Is Century Enka's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Century Enka's ROCE appears to be significantly below the 12% average in the Luxury industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Century Enka stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. You can check if Century Enka has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Century Enka'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Century Enka has total assets of ₹12b and current liabilities of ₹1.3b. Therefore its current liabilities are equivalent to approximately 10% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Century Enka's ROCE
Century Enka has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Century Enka. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Century Enka better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.
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