Today we'll evaluate Marshall Machines Limited (NSE:MARSHALL) 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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. 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 Marshall Machines:
0.39 = ₹109m ÷ (₹796m - ₹516m) (Based on the trailing twelve months to March 2018.)
So, Marshall Machines has an ROCE of 39%.
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Does Marshall Machines Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Marshall Machines's ROCE is meaningfully higher than the 16% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Marshall Machines's ROCE in absolute terms currently looks quite high.
Our data shows that Marshall Machines currently has an ROCE of 39%, compared to its ROCE of 20% 3 years ago. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and 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, after all, simply a snap shot of a single year. If Marshall Machines is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Marshall Machines's Current Liabilities Impact 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Marshall Machines has total liabilities of ₹516m and total assets of ₹796m. As a result, its current liabilities are equal to approximately 65% of its total assets. Marshall Machines's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Marshall Machines's ROCE
So to us, the company is potentially worth investigating further. There might be better investments than Marshall Machines out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 firstname.lastname@example.org. 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.