Today we are going to look at Hi-Tech Pipes Limited (NSE:HITECH) to see whether it might be an attractive investment prospect. 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.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. 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 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. Ultimately, it is a useful but imperfect metric. 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 Hi-Tech Pipes:
0.25 = ₹625m ÷ (₹5.4b - ₹2.9b) (Based on the trailing twelve months to September 2019.)
So, Hi-Tech Pipes has an ROCE of 25%.
Is Hi-Tech Pipes's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Hi-Tech Pipes's ROCE is meaningfully better than the 14% average in the Metals and Mining 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. Setting aside the comparison to its industry for a moment, Hi-Tech Pipes's ROCE in absolute terms currently looks quite high.
You can see in the image below how Hi-Tech Pipes's ROCE compares to its industry.
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. Remember that most companies like Hi-Tech Pipes are cyclical businesses. You can check if Hi-Tech Pipes has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Hi-Tech Pipes's 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.
Hi-Tech Pipes has total assets of ₹5.4b and current liabilities of ₹2.9b. Therefore its current liabilities are equivalent to approximately 53% of its total assets. Hi-Tech Pipes boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On Hi-Tech Pipes's ROCE
So we would be interested in doing more research here -- there may be an opportunity! Hi-Tech Pipes 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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