Today we are going to look at Butterfly Gandhimathi Appliances Limited (NSE:BUTTERFLY) 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Butterfly Gandhimathi Appliances:
0.15 = ₹353m ÷ (₹4.6b - ₹2.3b) (Based on the trailing twelve months to June 2019.)
So, Butterfly Gandhimathi Appliances has an ROCE of 15%.
Does Butterfly Gandhimathi Appliances Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Butterfly Gandhimathi Appliances's ROCE is around the 17% average reported by the Consumer Durables industry. Separate from how Butterfly Gandhimathi Appliances stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
The image below shows how Butterfly Gandhimathi Appliances's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Butterfly Gandhimathi Appliances's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Butterfly Gandhimathi Appliances has total liabilities of ₹2.3b and total assets of ₹4.6b. Therefore its current liabilities are equivalent to approximately 50% of its total assets. With a high level of current liabilities, Butterfly Gandhimathi Appliances will experience a boost to its ROCE.
Our Take On Butterfly Gandhimathi Appliances's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. 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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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.