Today we’ll evaluate Bodal Chemicals Limited (NSE:BODALCHEM) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting 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. 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?
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 Bodal Chemicals:
0.22 = ₹2.0b ÷ (₹13b – ₹4.1b) (Based on the trailing twelve months to June 2019.)
So, Bodal Chemicals has an ROCE of 22%.
Does Bodal Chemicals Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Bodal Chemicals’s ROCE is meaningfully higher than the 17% average in the Chemicals 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. Independently of how Bodal Chemicals compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Bodal Chemicals currently has an ROCE of 22%, less than the 60% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Bodal Chemicals’s ROCE compares to its industry.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Bodal Chemicals’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Bodal Chemicals has total liabilities of ₹4.1b and total assets of ₹13b. Therefore its current liabilities are equivalent to approximately 32% of its total assets. With this level of current liabilities, Bodal Chemicals’s ROCE is boosted somewhat.
Our Take On Bodal Chemicals’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. There might be better investments than Bodal Chemicals 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 free list of growing companies with recent insider purchasing, could be just the ticket.
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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.