Why You Should Care About SJVN Limited’s (NSE:SJVN) Low Return On Capital

Today we’ll evaluate SJVN Limited (NSE:SJVN) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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?

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 SJVN:

0.099 = ₹13b ÷ (₹144b – ₹8.2b) (Based on the trailing twelve months to March 2018.)

So, SJVN has an ROCE of 9.9%.

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Does SJVN Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see SJVN’s ROCE is around the 8.3% average reported by the Electric Utilities industry. Independently of how SJVN compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. Readers may wish to look for more rewarding investments.

As we can see, SJVN currently has an ROCE of 9.9%, less than the 13% it reported 3 years ago. This makes us wonder if the business is facing new challenges.

NSEI:SJVN Last Perf January 22nd 19
NSEI:SJVN Last Perf January 22nd 19

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 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for SJVN.

SJVN’s Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

SJVN has total assets of ₹144b and current liabilities of ₹8.2b. Therefore its current liabilities are equivalent to approximately 5.7% of its total assets. SJVN has a low level of current liabilities, which have a negligible impact on its already low ROCE.

What We Can Learn From SJVN’s ROCE

Still, investors could probably find more attractive prospects with better performance out there. But note: SJVN may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.com.