Today we are going to look at Centum Electronics Limited (NSE:CENTUM) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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. 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?
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 Centum Electronics:
0.23 = ₹878m ÷ (₹11b - ₹7.1b) (Based on the trailing twelve months to June 2019.)
So, Centum Electronics has an ROCE of 23%.
Does Centum Electronics Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Centum Electronics's ROCE is meaningfully better than the 14% average in the Electronic industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Centum Electronics compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Centum Electronics currently has an ROCE of 23% compared to its ROCE 3 years ago, which was 15%. This makes us wonder if the company is improving. The image below shows how Centum Electronics's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Centum Electronics 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 Centum Electronics's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Centum Electronics has total liabilities of ₹7.1b and total assets of ₹11b. Therefore its current liabilities are equivalent to approximately 65% of its total assets. Centum Electronics has a relatively high level of current liabilities, boosting its ROCE meaningfully.
The Bottom Line On Centum Electronics's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Centum Electronics 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 Centum Electronics 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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