Today we'll evaluate Indus Gas Limited (LON:INDI) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
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. Overall, it is a valuable metric that has its flaws. 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 Indus Gas:
0.059 = US$53m ÷ (US$948m - US$50m) (Based on the trailing twelve months to March 2019.)
Therefore, Indus Gas has an ROCE of 5.9%.
Is Indus Gas's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Indus Gas's ROCE appears to be significantly below the 10% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Indus Gas's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
You can see in the image below how Indus Gas's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. Remember that most companies like Indus Gas are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Indus Gas.
How Indus Gas'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.
Indus Gas has total liabilities of US$50m and total assets of US$948m. Therefore its current liabilities are equivalent to approximately 5.3% of its total assets. With low levels of current liabilities, at least Indus Gas's mediocre ROCE is not unduly boosted.
What We Can Learn From Indus Gas's ROCE
Based on this information, Indus Gas appears to be a mediocre business. You might be able to find a better investment than Indus Gas. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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.