Today we'll evaluate Liberty Shoes Limited (NSE:LIBERTSHOE) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Liberty Shoes:
0.14 = ₹284m ÷ (₹4.2b - ₹2.2b) (Based on the trailing twelve months to June 2019.)
So, Liberty Shoes has an ROCE of 14%.
Does Liberty Shoes Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Liberty Shoes's ROCE is fairly close to the Luxury industry average of 12%. Separate from how Liberty Shoes stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how Liberty Shoes's ROCE compares to its industry. Click to see more on 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. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Liberty Shoes's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Liberty Shoes has total liabilities of ₹2.2b and total assets of ₹4.2b. Therefore its current liabilities are equivalent to approximately 52% of its total assets. Liberty Shoes has a fairly high level of current liabilities, meaningfully impacting its ROCE.
The Bottom Line On Liberty Shoes's ROCE
Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. Of course, you might also be able to find a better stock than Liberty Shoes. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.