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Today we'll evaluate Dhunseri Tea & Industries Limited (NSE:DHUNTEAIND) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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'.
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 Dhunseri Tea & Industries:
0.053 = ₹488m ÷ (₹10b - ₹1.1b) (Based on the trailing twelve months to March 2019.)
So, Dhunseri Tea & Industries has an ROCE of 5.3%.
Is Dhunseri Tea & Industries's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Dhunseri Tea & Industries's ROCE appears to be significantly below the 12% average in the Food industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Dhunseri Tea & Industries stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
We can see that , Dhunseri Tea & Industries currently has an ROCE of 5.3%, less than the 8.0% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Dhunseri Tea & Industries's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Dhunseri Tea & Industries? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Dhunseri Tea & Industries's Current Liabilities Skew Its 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 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.
Dhunseri Tea & Industries has total assets of ₹10b and current liabilities of ₹1.1b. As a result, its current liabilities are equal to approximately 11% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Dhunseri Tea & Industries's ROCE
That's not a bad thing, however Dhunseri Tea & Industries has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Dhunseri Tea & Industries. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Dhunseri Tea & Industries 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 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.