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Why Joint-Stock Company Krasnyj Octyabr’s (MCX:KROT) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we are going to look at Joint-Stock Company Krasnyj Octyabr (MCX:KROT) to see whether it might be an attractive investment prospect. 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.

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. Overall, it is a valuable metric that has its flaws. 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?

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 Krasnyj Octyabr:

0.037 = ₽390m ÷ (₽13b - ₽2.5b) (Based on the trailing twelve months to September 2019.)

So, Krasnyj Octyabr has an ROCE of 3.7%.

Check out our latest analysis for Krasnyj Octyabr

Does Krasnyj Octyabr Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Krasnyj Octyabr's ROCE is meaningfully below the Food industry average of 8.6%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Krasnyj Octyabr'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.

Krasnyj Octyabr's current ROCE of 3.7% is lower than 3 years ago, when the company reported a 12% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Krasnyj Octyabr's ROCE compares to its industry, and you can click it to see more detail on its past growth.

MISX:KROT Past Revenue and Net Income, January 15th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. You can check if Krasnyj Octyabr has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Krasnyj Octyabr's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Krasnyj Octyabr has total assets of ₽13b and current liabilities of ₽2.5b. Therefore its current liabilities are equivalent to approximately 19% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Krasnyj Octyabr's ROCE

That's not a bad thing, however Krasnyj Octyabr has a weak ROCE and may not be an attractive investment. 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.

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.

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. Thank you for reading.