In This Article:
Today we are going to look at Century Enka Limited (NSE:CENTENKA) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
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 Century Enka:
0.089 = ₹983m ÷ (₹12b - ₹1.3b) (Based on the trailing twelve months to June 2019.)
So, Century Enka has an ROCE of 8.9%.
Check out our latest analysis for Century Enka
Is Century Enka's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Century Enka's ROCE appears to be significantly below the 12% average in the Luxury industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Century Enka compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. There are potentially more appealing investments elsewhere.
You can see in the image below how Century Enka's ROCE compares to its industry. Click to see more on past growth.
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. If Century Enka is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Century Enka's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.