Why We’re Not Keen On Lovable Lingerie Limited’s (NSE:LOVABLE) 2.5% Return On Capital

Today we'll look at Lovable Lingerie Limited (NSE:LOVABLE) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we'll go over how we 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.

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. Generally speaking a higher ROCE is better. 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.

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 Lovable Lingerie:

0.025 = ₹44m ÷ (₹2.0b - ₹266m) (Based on the trailing twelve months to June 2019.)

So, Lovable Lingerie has an ROCE of 2.5%.

Check out our latest analysis for Lovable Lingerie

Does Lovable Lingerie Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Lovable Lingerie'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. Putting aside Lovable Lingerie's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

Lovable Lingerie's current ROCE of 2.5% is lower than 3 years ago, when the company reported a 13% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Lovable Lingerie's ROCE compares to its industry.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is Lovable Lingerie? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do Lovable Lingerie'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.

Lovable Lingerie has total assets of ₹2.0b and current liabilities of ₹266m. As a result, its current liabilities are equal to approximately 13% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Lovable Lingerie's ROCE

Lovable Lingerie 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 Lovable Lingerie. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.