Today we’ll evaluate Patel Engineering Limited (NSE:PATELENG) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Patel Engineering:
0.12 = ₹4.8b ÷ (₹74b – ₹34b) (Based on the trailing twelve months to March 2018.)
Therefore, Patel Engineering has an ROCE of 12%.
Does Patel Engineering Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Patel Engineering’s ROCE is around the 12% average reported by the Construction industry. Setting aside the industry comparison for now, Patel Engineering’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
In our analysis, Patel Engineering’s ROCE appears to be 12%, compared to 3 years ago, when its ROCE was 8.9%. This makes us think the business might be improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Patel Engineering? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Patel Engineering’s Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Patel Engineering has total liabilities of ₹34b and total assets of ₹74b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Patel Engineering’s ROCE is improved somewhat by its moderate amount of current liabilities.
Our Take On Patel Engineering’s ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. But note: Patel Engineering may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.