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Is Indraprastha Gas Limited's (NSE:IGL) Capital Allocation Ability Worth Your Time?

Simply Wall St

Today we are going to look at Indraprastha Gas Limited (NSE:IGL) 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. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Indraprastha Gas:

0.24 = ₹11b ÷ (₹62b - ₹15b) (Based on the trailing twelve months to June 2019.)

Therefore, Indraprastha Gas has an ROCE of 24%.

View our latest analysis for Indraprastha Gas

Does Indraprastha Gas Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Indraprastha Gas's ROCE appears to be around the 23% average of the Gas Utilities industry. Independently of how Indraprastha Gas compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can click on the image below to see (in greater detail) how Indraprastha Gas's past growth compares to other companies.

NSEI:IGL Past Revenue and Net Income, October 1st 2019
NSEI:IGL Past Revenue and Net Income, October 1st 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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.

Indraprastha Gas's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Indraprastha Gas has total liabilities of ₹15b and total assets of ₹62b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On Indraprastha Gas's ROCE

With that in mind, Indraprastha Gas's ROCE appears pretty good. Indraprastha Gas 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.

I will like Indraprastha Gas better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 editorial-team@simplywallst.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.