Today we’ll evaluate Dollar Industries Limited (NSE:DOLLAR) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to 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. In general, businesses with a higher ROCE are usually better quality. 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 Dollar Industries:
0.24 = ₹1.1b ÷ (₹7.9b – ₹3.4b) (Based on the trailing twelve months to September 2019.)
Therefore, Dollar Industries has an ROCE of 24%.
Is Dollar Industries’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Dollar Industries’s ROCE appears to be substantially greater than the 11% average in the Luxury industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Dollar Industries sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how Dollar Industries’s ROCE compares to its industry. Click to see more on past growth.
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 only a point-in-time measure. If Dollar Industries is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Dollar Industries’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Dollar Industries has total liabilities of ₹3.4b and total assets of ₹7.9b. Therefore its current liabilities are equivalent to approximately 43% of its total assets. Dollar Industries has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Dollar Industries’s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Dollar Industries 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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