Are Action Construction Equipment Limited’s Returns On Capital Worth Investigating?

Sam Bishop

Tue, Feb 5, 2019, 5:46 PM

Today we are going to look at Action Construction Equipment Limited (NSE:ACE) to see whether it might be an attractive investment prospect. 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. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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’.

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 Action Construction Equipment:

0.17 = ₹807m ÷ (₹8.2b – ₹3.5b) (Based on the trailing twelve months to March 2018.)

Therefore, Action Construction Equipment has an ROCE of 17%.

Check out our latest analysis for Action Construction Equipment

Does Action Construction Equipment Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Action Construction Equipment’s ROCE is around the 15% average reported by the Machinery industry. Independently of how Action Construction Equipment compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

In our analysis, Action Construction Equipment’s ROCE appears to be 17%, compared to 3 years ago, when its ROCE was 3.4%. This makes us think the business might be improving.

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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Action Construction Equipment.