Today we'll evaluate V-Guard Industries Limited (NSE:VGUARD) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 V-Guard Industries:
0.25 = ₹2.3b ÷ (₹14b - ₹4.6b) (Based on the trailing twelve months to June 2019.)
So, V-Guard Industries has an ROCE of 25%.
Is V-Guard Industries's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that V-Guard Industries's ROCE is meaningfully better than the 13% average in the Electrical industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where V-Guard Industries sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
V-Guard Industries's current ROCE of 25% is lower than its ROCE in the past, which was 37%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how V-Guard Industries's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do V-Guard Industries's Current Liabilities Skew 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. 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.
V-Guard Industries has total assets of ₹14b and current liabilities of ₹4.6b. As a result, its current liabilities are equal to approximately 33% of its total assets. V-Guard Industries has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On V-Guard Industries's ROCE
V-Guard Industries's ROCE does look good, but the level of current liabilities also contribute to that. V-Guard Industries 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.
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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.