In This Article:
Today we'll look at Ambuja Cements Limited (NSE:AMBUJACEM) 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. Then we'll compare its ROCE 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 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. Overall, it is a valuable metric that has its flaws. 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?
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 Ambuja Cements:
0.10 = ₹31b ÷ (₹384b - ₹84b) (Based on the trailing twelve months to June 2019.)
So, Ambuja Cements has an ROCE of 10%.
See our latest analysis for Ambuja Cements
Does Ambuja Cements Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Ambuja Cements's ROCE appears to be around the 10% average of the Basic Materials industry. Independently of how Ambuja Cements 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.
We can see that , Ambuja Cements currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 7.5%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Ambuja Cements's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ambuja Cements.
How Ambuja Cements'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 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 counter this, investors can check if a company has high current liabilities relative to total assets.