Today we are going to look at Crompton Greaves Consumer Electricals Limited (NSE:CROMPTON) to see whether it might be an attractive investment prospect. 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
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 the end, ROCE is a valuable metric that has its flaws. 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 Crompton Greaves Consumer Electricals:
0.46 = ₹5.2b ÷ (₹23b – ₹11b) (Based on the trailing twelve months to September 2018.)
So, Crompton Greaves Consumer Electricals has an ROCE of 46%.
Is Crompton Greaves Consumer Electricals’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Crompton Greaves Consumer Electricals’s ROCE is meaningfully higher than the 16% average in the Consumer Durables 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, Crompton Greaves Consumer Electricals’s ROCE in absolute terms currently looks quite high.
As we can see, Crompton Greaves Consumer Electricals currently has an ROCE of 46% compared to its ROCE 3 years ago, which was 23%. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is 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, 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 Crompton Greaves Consumer Electricals.
Do Crompton Greaves Consumer Electricals’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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) unfairly boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Crompton Greaves Consumer Electricals has total liabilities of ₹11b and total assets of ₹23b. Therefore its current liabilities are equivalent to approximately 48% of its total assets. Crompton Greaves Consumer Electricals’s ROCE is boosted somewhat by its middling amount of current liabilities.
Our Take On Crompton Greaves Consumer Electricals’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. We like to see a high ROCE, but it’s not the only data point we check. For example, I often check if insiders have been buying shares .
Of course Crompton Greaves Consumer Electricals may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.