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Here’s why Clariant Chemicals (India) Limited’s (NSE:CLNINDIA) Returns On Capital Matters So Much

Today we are going to look at Clariant Chemicals (India) Limited (NSE:CLNINDIA) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'

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 Clariant Chemicals (India):

0.032 = ₹211m ÷ (₹9.0b - ₹2.4b) (Based on the trailing twelve months to December 2018.)

Therefore, Clariant Chemicals (India) has an ROCE of 3.2%.

Does Clariant Chemicals (India) Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Clariant Chemicals (India)'s ROCE is meaningfully below the Chemicals industry average of 16%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Clariant Chemicals (India)'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.

Clariant Chemicals (India) has an ROCE of 3.2%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. You can check if Clariant Chemicals (India) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Clariant Chemicals (India)'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Clariant Chemicals (India) has total liabilities of ₹2.4b and total assets of ₹9.0b. As a result, its current liabilities are equal to approximately 27% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

The Bottom Line On Clariant Chemicals (India)'s ROCE

While that is good to see, Clariant Chemicals (India) has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. 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 are like me, then you will not want to miss this free list of growing companies that insiders are 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.