Today we’ll evaluate Sarla Performance Fibers Limited (NSE:SARLAPOLY) 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. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Sarla Performance Fibers:
0.081 = ₹346m ÷ (₹5.6b – ₹1.4b) (Based on the trailing twelve months to March 2018.)
So, Sarla Performance Fibers has an ROCE of 8.1%.
Is Sarla Performance Fibers’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Sarla Performance Fibers’s ROCE appears to be significantly below the 11% average in the Luxury industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Sarla Performance Fibers compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. Readers may wish to look for more rewarding investments.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Sarla Performance Fibers is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Sarla Performance Fibers’s Current Liabilities Skew Its 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.
Sarla Performance Fibers has total assets of ₹5.6b and current liabilities of ₹1.4b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Sarla Performance Fibers’s ROCE
While that is good to see, Sarla Performance Fibers has a low ROCE and does not look attractive in this analysis. You might be able to find a better buy than Sarla Performance Fibers. 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 firstname.lastname@example.org. 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.