Today we are going to look at Advanced Enzyme Technologies Limited (NSE:ADVENZYMES) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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. 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'.
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 Advanced Enzyme Technologies:
0.20 = ₹1.8b ÷ (₹9.8b - ₹650m) (Based on the trailing twelve months to March 2020.)
Therefore, Advanced Enzyme Technologies has an ROCE of 20%.
Is Advanced Enzyme Technologies's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Advanced Enzyme Technologies's ROCE is meaningfully better than the 16% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Advanced Enzyme Technologies sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Advanced Enzyme Technologies's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 free report on analyst forecasts for Advanced Enzyme Technologies.
How Advanced Enzyme Technologies'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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Advanced Enzyme Technologies has current liabilities of ₹650m and total assets of ₹9.8b. Therefore its current liabilities are equivalent to approximately 6.6% of its total assets. Low current liabilities have only a minimal impact on Advanced Enzyme Technologies's ROCE, making its decent returns more credible.
The Bottom Line On Advanced Enzyme Technologies's ROCE
If it is able to keep this up, Advanced Enzyme Technologies could be attractive. There might be better investments than Advanced Enzyme Technologies out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.
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