Today we'll evaluate Prakash Pipes Limited (NSE:PPL) 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.
First up, we'll look at what ROCE is and how we calculate it. 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Prakash Pipes:
0.34 = ₹378m ÷ (₹1.4b - ₹290m) (Based on the trailing twelve months to June 2019.)
Therefore, Prakash Pipes has an ROCE of 34%.
Does Prakash Pipes Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Prakash Pipes's ROCE is meaningfully better than the 14% average in the Building industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Prakash Pipes's ROCE currently appears to be excellent.
The image below shows how Prakash Pipes's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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, after all, simply a snap shot of a single year. How cyclical is Prakash Pipes? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Prakash Pipes'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Prakash Pipes has total liabilities of ₹290m and total assets of ₹1.4b. As a result, its current liabilities are equal to approximately 21% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Prakash Pipes's ROCE
With low current liabilities and a high ROCE, Prakash Pipes could be worthy of further investigation. There might be better investments than Prakash Pipes 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.