Today we are going to look at Omax Autos Limited (NSE:OMAXAUTO) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is 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'.
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 Omax Autos:
0.14 = ₹425m ÷ (₹5.9b - ₹2.9b) (Based on the trailing twelve months to June 2019.)
Therefore, Omax Autos has an ROCE of 14%.
Is Omax Autos's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Omax Autos's ROCE is fairly close to the Auto Components industry average of 15%. Separate from Omax Autos's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Omax Autos's ROCE appears to be 14%, compared to 3 years ago, when its ROCE was 7.3%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Omax Autos's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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 Omax Autos? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Omax Autos's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Omax Autos has total assets of ₹5.9b and current liabilities of ₹2.9b. Therefore its current liabilities are equivalent to approximately 49% of its total assets. With this level of current liabilities, Omax Autos's ROCE is boosted somewhat.
The Bottom Line On Omax Autos's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Omax Autos 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 firstname.lastname@example.org. 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.