Why Dhanuka Agritech Limited’s (NSE:DHANUKA) Return On Capital Employed Is Impressive

Today we'll evaluate Dhanuka Agritech Limited (NSE:DHANUKA) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we 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.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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.'

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 Dhanuka Agritech:

0.21 = ₹1.4b ÷ (₹8.4b - ₹1.6b) (Based on the trailing twelve months to June 2019.)

Therefore, Dhanuka Agritech has an ROCE of 21%.

Check out our latest analysis for Dhanuka Agritech

Is Dhanuka Agritech's ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Dhanuka Agritech's ROCE is meaningfully higher than the 17% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Dhanuka Agritech's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

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. 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 Dhanuka Agritech.

How Dhanuka Agritech'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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Dhanuka Agritech has total liabilities of ₹1.6b and total assets of ₹8.4b. Therefore its current liabilities are equivalent to approximately 20% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On Dhanuka Agritech's ROCE

This is good to see, and with a sound ROCE, Dhanuka Agritech could be worth a closer look. Dhanuka Agritech 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.

I will like Dhanuka Agritech better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 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.