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Today we’ll evaluate Sree Rayalaseema Hi-Strength Hypo Limited (NSE:SRHHYPOLTD) to determine whether it could have potential as an investment idea. 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is 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. All else being equal, a better business will have a higher ROCE. 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.’
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 Sree Rayalaseema Hi-Strength Hypo:
0.07 = ₹253m ÷ (₹4.7b – ₹1.1b) (Based on the trailing twelve months to March 2018.)
So, Sree Rayalaseema Hi-Strength Hypo has an ROCE of 7.0%.
Is Sree Rayalaseema Hi-Strength Hypo’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Sree Rayalaseema Hi-Strength Hypo’s ROCE appears meaningfully below the 16% average reported by the Chemicals industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Sree Rayalaseema Hi-Strength Hypo stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Sree Rayalaseema Hi-Strength Hypo’s current ROCE of 7.0% is lower than its ROCE in the past, which was 14%, 3 years ago. This makes us wonder if the business is facing new challenges.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. You can check if Sree Rayalaseema Hi-Strength Hypo 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 Sree Rayalaseema Hi-Strength Hypo’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Sree Rayalaseema Hi-Strength Hypo has total assets of ₹4.7b and current liabilities of ₹1.1b. As a result, its current liabilities are equal to approximately 23% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
What We Can Learn From Sree Rayalaseema Hi-Strength Hypo’s ROCE
While that is good to see, Sree Rayalaseema Hi-Strength Hypo has a low ROCE and does not look attractive in this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.