Today we'll look at D-Link (India) Limited (NSE:DLINKINDIA) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 D-Link (India):
0.23 = ₹475m ÷ (₹3.4b - ₹1.3b) (Based on the trailing twelve months to June 2019.)
Therefore, D-Link (India) has an ROCE of 23%.
Is D-Link (India)'s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that D-Link (India)'s ROCE is meaningfully better than the 14% average in the Electronic industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how D-Link (India) compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how D-Link (India)'s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 D-Link (India) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do D-Link (India)'s Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
D-Link (India) has total assets of ₹3.4b and current liabilities of ₹1.3b. Therefore its current liabilities are equivalent to approximately 38% of its total assets. D-Link (India) has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On D-Link (India)'s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than D-Link (India) out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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If you spot an error that warrants correction, please contact the editor at email@example.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.