Today we'll look at Transformers & Rectifiers (India) Limited (NSE:TRIL) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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.'
So, How Do We Calculate ROCE?
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 Transformers & Rectifiers (India):
0.12 = ₹439m ÷ (₹11b - ₹7.2b) (Based on the trailing twelve months to March 2018.)
So, Transformers & Rectifiers (India) has an ROCE of 12%.
Does Transformers & Rectifiers (India) Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Transformers & Rectifiers (India)'s ROCE is meaningfully below the Electrical industry average of 15%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Transformers & Rectifiers (India)'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.
Our data shows that Transformers & Rectifiers (India) currently has an ROCE of 12%, compared to its ROCE of 4.1% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if Transformers & Rectifiers (India) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Transformers & Rectifiers (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.
Transformers & Rectifiers (India) has total assets of ₹11b and current liabilities of ₹7.2b. As a result, its current liabilities are equal to approximately 66% of its total assets. Transformers & Rectifiers (India) has a fairly high level of current liabilities, meaningfully impacting its ROCE.
Our Take On Transformers & Rectifiers (India)'s ROCE
Even so, the company reports a mediocre ROCE, and there may be better investments out there. Of course, you might also be able to find a better stock than Transformers & Rectifiers (India). So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Transformers & Rectifiers (India) 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.