Today we’ll evaluate Suryalakshmi Cotton Mills Limited (NSE:SURYALAXMI) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. 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. 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 Suryalakshmi Cotton Mills:
0.08 = ₹362m ÷ (₹8.5b – ₹3.8b) (Based on the trailing twelve months to September 2018.)
So, Suryalakshmi Cotton Mills has an ROCE of 8.0%.
Is Suryalakshmi Cotton Mills’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Suryalakshmi Cotton Mills’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. Putting aside Suryalakshmi Cotton Mills’s performance relative to its industry, its ROCE in absolute terms is poor – not much better than government bonds. There are potentially more appealing investments elsewhere.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Suryalakshmi Cotton Mills is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Suryalakshmi Cotton Mills’s Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Suryalakshmi Cotton Mills has total liabilities of ₹3.8b and total assets of ₹8.5b. As a result, its current liabilities are equal to approximately 45% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Suryalakshmi Cotton Mills’s ROCE is concerning.
The Bottom Line On Suryalakshmi Cotton Mills’s ROCE
So researching other companies may be a better use of your time. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
Of course Suryalakshmi Cotton Mills 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.