Why G.M.Breweries Limited’s (NSE:GMBREW) Return On Capital Employed Is Impressive

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Today we are going to look at G.M.Breweries Limited (NSE:GMBREW) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it 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?

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 G.M.Breweries:

0.30 = ₹1.1b ÷ (₹4.2b - ₹523m) (Based on the trailing twelve months to March 2019.)

Therefore, G.M.Breweries has an ROCE of 30%.

Check out our latest analysis for G.M.Breweries

Does G.M.Breweries Have A Good ROCE?

One way to assess ROCE is to compare similar companies. G.M.Breweries's ROCE appears to be substantially greater than the 17% average in the Beverage industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, G.M.Breweries's ROCE currently appears to be excellent.

G.M.Breweries's current ROCE of 30% is lower than its ROCE in the past, which was 43%, 3 years ago. So investors might consider if it has had issues recently.

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. Since the future is so important for investors, you should check out our freereport on analyst forecasts for G.M.Breweries.

How G.M.Breweries'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) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

G.M.Breweries has total assets of ₹4.2b and current liabilities of ₹523m. As a result, its current liabilities are equal to approximately 12% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.

The Bottom Line On G.M.Breweries's ROCE

Low current liabilities and high ROCE is a good combination, making G.M.Breweries look quite interesting. G.M.Breweries looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

If you like to buy stocks alongside management, then you might just love this freelist 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.