Today we are going to look at GMM Pfaudler Limited (NSE:GMMPFAUDLR) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 GMM Pfaudler:
0.26 = ₹756m ÷ (₹4.3b - ₹1.4b) (Based on the trailing twelve months to June 2019.)
Therefore, GMM Pfaudler has an ROCE of 26%.
Is GMM Pfaudler's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. GMM Pfaudler's ROCE appears to be substantially greater than the 13% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, GMM Pfaudler's ROCE is currently very good.
Our data shows that GMM Pfaudler currently has an ROCE of 26%, compared to its ROCE of 18% 3 years ago. This makes us think the business might be improving. The image below shows how GMM Pfaudler'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How GMM Pfaudler's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
GMM Pfaudler has total assets of ₹4.3b and current liabilities of ₹1.4b. As a result, its current liabilities are equal to approximately 33% of its total assets. GMM Pfaudler has a medium level of current liabilities, boosting its ROCE somewhat.
Our Take On GMM Pfaudler's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. GMM Pfaudler 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.
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We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.