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Today we’ll look at Shanti Overseas (India) Limited (NSE:SHANTI) 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.
Firstly, 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 measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Shanti Overseas (India):
0.25 = ₹97m ÷ (₹804m – ₹420m) (Based on the trailing twelve months to March 2018.)
Therefore, Shanti Overseas (India) has an ROCE of 25%.
See our latest analysis for Shanti Overseas (India)
Is Shanti Overseas (India)’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Shanti Overseas (India)’s ROCE is meaningfully better than the 14% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Shanti Overseas (India)’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. How cyclical is Shanti Overseas (India)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Shanti Overseas (India)’s Current Liabilities Skew 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.