Today we are going to look at Creative Peripherals and Distribution Limited (NSE:CREATIVE) 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. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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’.
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 Creative Peripherals and Distribution:
0.22 = ₹62m ÷ (₹1.0b – ₹736m) (Based on the trailing twelve months to March 2018.)
So, Creative Peripherals and Distribution has an ROCE of 22%.
Is Creative Peripherals and Distribution’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Creative Peripherals and Distribution’s ROCE is meaningfully higher than the 9.8% average in the Electronic industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Creative Peripherals and Distribution’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
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. You can check if Creative Peripherals and Distribution 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 Creative Peripherals and Distribution’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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Creative Peripherals and Distribution has total liabilities of ₹736m and total assets of ₹1.0b. As a result, its current liabilities are equal to approximately 72% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
The Bottom Line On Creative Peripherals and Distribution’s ROCE
While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. You might be able to find a better buy than Creative Peripherals and Distribution. 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 Creative Peripherals and Distribution better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.