Today we'll look at Eimco Elecon (India) Limited (NSE:EIMCOELECO) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. Ultimately, it is a useful but imperfect metric. 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 Eimco Elecon (India):
0.048 = ₹157m ÷ (₹3.5b - ₹222m) (Based on the trailing twelve months to September 2019.)
Therefore, Eimco Elecon (India) has an ROCE of 4.8%.
Is Eimco Elecon (India)'s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Eimco Elecon (India)'s ROCE appears to be significantly below the 13% average in the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Eimco Elecon (India) compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. Readers may wish to look for more rewarding investments.
You can see in the image below how Eimco Elecon (India)'s ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Eimco Elecon (India)'s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Eimco Elecon (India) has total liabilities of ₹222m and total assets of ₹3.5b. As a result, its current liabilities are equal to approximately 6.4% of its total assets. With barely any current liabilities, there is minimal impact on Eimco Elecon (India)'s admittedly low ROCE.
The Bottom Line On Eimco Elecon (India)'s ROCE
Nonetheless, there may be better places to invest your capital. Of course, you might also be able to find a better stock than Eimco Elecon (India). So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.