Today we’ll evaluate S K S Textiles Limited (NSE:SKSTEXTILE) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. In brief, ROCE is a useful tool, but it is not without drawbacks. 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’.
So, How Do We Calculate ROCE?
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 S K S Textiles:
0.20 = ₹85m ÷ (₹1.2b – ₹743m) (Based on the trailing twelve months to March 2018.)
Therefore, S K S Textiles has an ROCE of 20%.
Does S K S Textiles Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, S K S Textiles’s ROCE is meaningfully higher than the 11% average in the Luxury industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where S K S Textiles sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, S K S Textiles’s ROCE appears to be 20%, compared to 3 years ago, when its ROCE was 16%. This makes us wonder if the company is improving.
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. If S K S Textiles is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do S K S Textiles’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
S K S Textiles has total assets of ₹1.2b and current liabilities of ₹743m. Therefore its current liabilities are equivalent to approximately 64% of its total assets. S K S Textiles has a relatively high level of current liabilities, boosting its ROCE meaningfully.
Our Take On S K S Textiles’s ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. Of course you might be able to find a better stock than S K S Textiles. So you may wish to see this free collection of other companies that have grown earnings strongly.
But note: S K S Textiles may not be the best stock to buy. So take a peek at this free list of interesting companies with 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.