Today we'll look at International Paper APPM Limited (NSE:IPAPPM) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the 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 International Paper APPM:
0.35 = ₹2.9b ÷ (₹11b - ₹2.7b) (Based on the trailing twelve months to December 2018.)
So, International Paper APPM has an ROCE of 35%.
Check out our latest analysis for International Paper APPM
Is International Paper APPM's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that International Paper APPM's ROCE is meaningfully better than the 16% average in the Forestry industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, International Paper APPM's ROCE currently appears to be excellent.
In our analysis, International Paper APPM's ROCE appears to be 35%, compared to 3 years ago, when its ROCE was 8.5%. This makes us wonder if the company is improving.
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. What happens in the future is pretty important for investors, so we have prepared a freereport on analyst forecasts for International Paper APPM.
How International Paper APPM's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
International Paper APPM has total liabilities of ₹2.7b and total assets of ₹11b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
Our Take On International Paper APPM's ROCE
This is good to see, and with such a high ROCE, International Paper APPM may be worth a closer look. There might be better investments than International Paper APPM 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.
For those who like to find winning investments this freelist of growing companies with recent insider purchasing, could be just the ticket.
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