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Today we’ll look at Lotus Eye Hospital and Institute Limited (NSE:LEHIL) 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Lotus Eye Hospital and Institute:
0.00029 = ₹151k ÷ (₹566m – ₹60m) (Based on the trailing twelve months to March 2019.)
Therefore, Lotus Eye Hospital and Institute has an ROCE of 0.03%.
Is Lotus Eye Hospital and Institute’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Lotus Eye Hospital and Institute’s ROCE appears meaningfully below the 15% average reported by the Healthcare industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Lotus Eye Hospital and Institute stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
Lotus Eye Hospital and Institute’s current ROCE of 0.03% is lower than its ROCE in the past, which was 0.6%, 3 years ago. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Lotus Eye Hospital and Institute has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Lotus Eye Hospital and Institute’s Current Liabilities And Their Impact On 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Lotus Eye Hospital and Institute has total liabilities of ₹60m and total assets of ₹566m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Lotus Eye Hospital and Institute’s ROCE
Lotus Eye Hospital and Institute has a poor ROCE, and there may be better investment prospects out there. 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.
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 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.