Today we’ll evaluate Jet Knitwears Limited (NSE:JETKNIT) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is 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?
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 Jet Knitwears:
0.16 = ₹26m ÷ (₹304m – ₹142m) (Based on the trailing twelve months to March 2018.)
So, Jet Knitwears has an ROCE of 16%.
Is Jet Knitwears’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Jet Knitwears’s ROCE appears to be substantially greater than the 11% average in the Luxury industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Jet Knitwears sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. How cyclical is Jet Knitwears? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Jet Knitwears’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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Jet Knitwears has total assets of ₹304m and current liabilities of ₹142m. As a result, its current liabilities are equal to approximately 47% of its total assets. Jet Knitwears has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Jet Knitwears’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. You might be able to find a better buy than Jet Knitwears. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
Of course Jet Knitwears 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.