Today we'll look at Atul Auto Limited (NSE:ATULAUTO) and reflect on its potential as an investment. 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.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Atul Auto:
0.28 = ₹759m ÷ (₹3.6b - ₹895m) (Based on the trailing twelve months to March 2019.)
So, Atul Auto has an ROCE of 28%.
Is Atul Auto's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Atul Auto's ROCE appears to be substantially greater than the 21% average in the Auto industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Atul Auto's ROCE is currently very good.
Atul Auto's current ROCE of 28% is lower than its ROCE in the past, which was 45%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Atul Auto's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Atul Auto.
What Are Current Liabilities, And How Do They Affect Atul Auto's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Atul Auto has total liabilities of ₹895m and total assets of ₹3.6b. As a result, its current liabilities are equal to approximately 25% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On Atul Auto's ROCE
With low current liabilities and a high ROCE, Atul Auto could be worthy of further investigation. Atul Auto looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Atul Auto 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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