Today we'll evaluate Gokul Refoils & Solvent Ltd (NSE:GOKUL) 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. 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.
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 Gokul Refoils & Solvent:
0.11 = ₹318m ÷ (₹6.1b - ₹3.2b) (Based on the trailing twelve months to June 2019.)
So, Gokul Refoils & Solvent has an ROCE of 11%.
Is Gokul Refoils & Solvent's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Gokul Refoils & Solvent's ROCE appears to be around the 13% average of the Food industry. Setting aside the industry comparison for now, Gokul Refoils & Solvent's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
You can see in the image below how Gokul Refoils & Solvent's ROCE compares to its industry. Click to see more on 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. ROCE is only a point-in-time measure. If Gokul Refoils & Solvent is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Gokul Refoils & Solvent's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Gokul Refoils & Solvent has total liabilities of ₹3.2b and total assets of ₹6.1b. Therefore its current liabilities are equivalent to approximately 53% of its total assets. Gokul Refoils & Solvent's current liabilities are fairly high, making its ROCE look better than otherwise.
The Bottom Line On Gokul Refoils & Solvent's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might also be able to find a better stock than Gokul Refoils & Solvent. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Gokul Refoils & Solvent 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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