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Today we’ll look at Sree Rayalaseema Hi-Strength Hypo Limited (NSE:SRHHYPOLTD) and reflect on its potential as an investment. 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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. 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?
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 Sree Rayalaseema Hi-Strength Hypo:
0.14 = ₹480m ÷ (₹4.7b – ₹1.2b) (Based on the trailing twelve months to March 2019.)
So, Sree Rayalaseema Hi-Strength Hypo has an ROCE of 14%.
Does Sree Rayalaseema Hi-Strength Hypo Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Sree Rayalaseema Hi-Strength Hypo’s ROCE is meaningfully below the Chemicals industry average of 17%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Sree Rayalaseema Hi-Strength Hypo stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. How cyclical is Sree Rayalaseema Hi-Strength Hypo? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Sree Rayalaseema Hi-Strength Hypo’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Sree Rayalaseema Hi-Strength Hypo has total assets of ₹4.7b and current liabilities of ₹1.2b. As a result, its current liabilities are equal to approximately 25% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Sree Rayalaseema Hi-Strength Hypo’s ROCE
If Sree Rayalaseema Hi-Strength Hypo continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Sree Rayalaseema Hi-Strength Hypo. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Sree Rayalaseema Hi-Strength Hypo 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 email@example.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.