Today we are going to look at HOV Services Limited (NSE:HOVS) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?
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 HOV Services:
0.0011 = ₹6.9m ÷ (₹6.1b - ₹41m) (Based on the trailing twelve months to March 2019.)
So, HOV Services has an ROCE of 0.1%.
Is HOV Services's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see HOV Services's ROCE is meaningfully below the IT industry average of 14%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside HOV Services's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
We can see that , HOV Services currently has an ROCE of 0.1%, less than the 0.2% it reported 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how HOV Services'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. How cyclical is HOV Services? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect HOV Services's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
HOV Services has total liabilities of ₹41m and total assets of ₹6.1b. As a result, its current liabilities are equal to approximately 0.7% of its total assets. With barely any current liabilities, there is minimal impact on HOV Services's admittedly low ROCE.
What We Can Learn From HOV Services's ROCE
Nonetheless, there may be better places to invest your capital. Of course, you might also be able to find a better stock than HOV Services. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like HOV Services 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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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.