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Why You Should Care About The Grob Tea Company Limited’s (NSE:GROBTEA) Low Return On Capital

Simply Wall St

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Today we'll evaluate The Grob Tea Company Limited (NSE:GROBTEA) 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. 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 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

How Do You Calculate Return On Capital Employed?

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 Grob Tea:

0.033 = ₹15m ÷ (₹688m - ₹221m) (Based on the trailing twelve months to March 2019.)

So, Grob Tea has an ROCE of 3.3%.

See our latest analysis for Grob Tea

Does Grob Tea Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Grob Tea's ROCE appears meaningfully below the 12% average reported by the Food industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Grob Tea stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

Grob Tea's current ROCE of 3.3% is lower than 3 years ago, when the company reported a 17% ROCE. So investors might consider if it has had issues recently.

NSEI:GROBTEA Past Revenue and Net Income, June 11th 2019

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. ROCE is only a point-in-time measure. If Grob Tea is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Grob Tea's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Grob Tea has total assets of ₹688m and current liabilities of ₹221m. As a result, its current liabilities are equal to approximately 32% of its total assets. Grob Tea has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.

Our Take On Grob Tea's ROCE

So researching other companies may be a better use of your time. You might be able to find a better investment than Grob Tea. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Grob Tea better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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 editorial-team@simplywallst.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.