Today we’ll look at Pennar Industries Limited (NSE:PENIND) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Pennar Industries:
0.18 = ₹1.5b ÷ (₹17b – ₹9.3b) (Based on the trailing twelve months to March 2019.)
So, Pennar Industries has an ROCE of 18%.
See our latest analysis for Pennar Industries
Does Pennar Industries Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Pennar Industries’s ROCE is fairly close to the Metals and Mining industry average of 15%. Independently of how Pennar Industries compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Pennar Industries could be considered a cyclical business. You can check if Pennar Industries 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 Pennar Industries’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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Pennar Industries has total assets of ₹17b and current liabilities of ₹9.3b. As a result, its current liabilities are equal to approximately 53% of its total assets. Pennar Industries has a relatively high level of current liabilities, boosting its ROCE meaningfully.
The Bottom Line On Pennar Industries’s ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. There might be better investments than Pennar Industries 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.
I will like Pennar Industries 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.