Today we are going to look at Nila Infrastructures Limited (NSE:NILA) to see whether it might be an attractive investment prospect. 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. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.
So, How Do We Calculate ROCE?
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 Nila Infrastructures:
0.20 = ₹340m ÷ (₹2.8b - ₹1.0b) (Based on the trailing twelve months to March 2019.)
Therefore, Nila Infrastructures has an ROCE of 20%.
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Is Nila Infrastructures's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Nila Infrastructures's ROCE is meaningfully better than the 12% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Nila Infrastructures's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Nila Infrastructures currently has an ROCE of 20% compared to its ROCE 3 years ago, which was 9.5%. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. You can check if Nila Infrastructures has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Nila Infrastructures's Current Liabilities And Their Impact On Its 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.
Nila Infrastructures has total assets of ₹2.8b and current liabilities of ₹1.0b. As a result, its current liabilities are equal to approximately 37% of its total assets. Nila Infrastructures has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Nila Infrastructures's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Nila Infrastructures out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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.