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Today we'll evaluate Powerful Technologies Limited (NSE:POWERFUL) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. 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?
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 Powerful Technologies:
0.082 = ₹25m ÷ (₹505m - ₹206m) (Based on the trailing twelve months to March 2019.)
So, Powerful Technologies has an ROCE of 8.2%.
Does Powerful Technologies Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Powerful Technologies's ROCE is meaningfully below the Consumer Durables industry average of 15%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Powerful Technologies's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
Powerful Technologies's current ROCE of 8.2% is lower than 3 years ago, when the company reported a 52% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Powerful Technologies'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Powerful Technologies? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Powerful Technologies'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Powerful Technologies has total assets of ₹505m and current liabilities of ₹206m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Powerful Technologies's low ROCE is unappealing.
What We Can Learn From Powerful Technologies's ROCE
So researching other companies may be a better use of your time. Of course, you might also be able to find a better stock than Powerful Technologies. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.