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Why We’re Not Keen On Oriental Trimex Limited’s (NSE:ORIENTALTL) 1.8% Return On Capital

Simply Wall St

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Today we are going to look at Oriental Trimex Limited (NSE:ORIENTALTL) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to 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.

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.'

So, How Do We Calculate ROCE?

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 Oriental Trimex:

0.018 = ₹15m ÷ (₹1.3b - ₹430m) (Based on the trailing twelve months to March 2019.)

Therefore, Oriental Trimex has an ROCE of 1.8%.

See our latest analysis for Oriental Trimex

Is Oriental Trimex's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see Oriental Trimex's ROCE is meaningfully below the Basic Materials industry average of 9.2%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Oriental Trimex's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

Oriental Trimex reported an ROCE of 1.8% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. The image below shows how Oriental Trimex's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NSEI:ORIENTALTL Past Revenue and Net Income, July 18th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. You can check if Oriental Trimex has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Oriental Trimex's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Oriental Trimex has total assets of ₹1.3b and current liabilities of ₹430m. As a result, its current liabilities are equal to approximately 33% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Oriental Trimex's ROCE is concerning.

Our Take On Oriental Trimex's ROCE

So researching other companies may be a better use of your time. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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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.