Today we'll evaluate D. P. Abhushan Limited (NSE:DPABHUSHAN) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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'.
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 D. P. Abhushan:
0.26 = ₹261m ÷ (₹2.3b - ₹1.3b) (Based on the trailing twelve months to March 2019.)
Therefore, D. P. Abhushan has an ROCE of 26%.
Does D. P. Abhushan Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that D. P. Abhushan's ROCE is meaningfully better than the 14% average in the Specialty Retail 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. Regardless of the industry comparison, in absolute terms, D. P. Abhushan's ROCE currently appears to be excellent.
In our analysis, D. P. Abhushan's ROCE appears to be 26%, compared to 3 years ago, when its ROCE was 14%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how D. P. Abhushan's past growth compares to other companies.
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. How cyclical is D. P. Abhushan? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
D. P. Abhushan's Current Liabilities And Their Impact On 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.
D. P. Abhushan has total liabilities of ₹1.3b and total assets of ₹2.3b. Therefore its current liabilities are equivalent to approximately 56% of its total assets. D. P. Abhushan boasts an attractive ROCE, even after considering the boost from high current liabilities.
Our Take On D. P. Abhushan's ROCE
In my book, this business could be worthy of further research. D. P. Abhushan 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.
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.