Today we are going to look at Zen Technologies Limited (NSE:ZENTEC) 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Zen Technologies:
0.13 = ₹160m ÷ (₹1.6b – ₹418m) (Based on the trailing twelve months to March 2019.)
Therefore, Zen Technologies has an ROCE of 13%.
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Does Zen Technologies Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Zen Technologies’s ROCE appears to be around the 11% average of the Electronic industry. Aside from the industry comparison, Zen Technologies’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Zen Technologies reported an ROCE of 13% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. How cyclical is Zen Technologies? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Zen Technologies’s Current Liabilities Impact Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Zen Technologies has total assets of ₹1.6b and current liabilities of ₹418m. Therefore its current liabilities are equivalent 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 Zen Technologies’s ROCE
That said, Zen Technologies’s ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.