Today we’ll look at Advanced Enzyme Technologies Limited (NSE:ADVENZYMES) and reflect on its potential as an investment. 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. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 Advanced Enzyme Technologies:
0.23 = ₹1.6b ÷ (₹8.2b – ₹1.1b) (Based on the trailing twelve months to December 2018.)
So, Advanced Enzyme Technologies has an ROCE of 23%.
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Does Advanced Enzyme Technologies Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Advanced Enzyme Technologies’s ROCE is meaningfully better than the 17% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Advanced Enzyme Technologies compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Advanced Enzyme Technologies’s current ROCE of 23% is lower than 3 years ago, when the company reported a 38% ROCE. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Advanced Enzyme Technologies.
Do Advanced Enzyme Technologies’s Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Advanced Enzyme Technologies has total liabilities of ₹1.1b and total assets of ₹8.2b. As a result, its current liabilities are equal to approximately 14% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Advanced Enzyme Technologies’s ROCE
Overall, Advanced Enzyme Technologies has a decent ROCE and could be worthy of further research. Advanced Enzyme Technologies 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 free list of companies. (Hint: insiders have been buying them).
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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.