Today we’ll look at Crompton Greaves Consumer Electricals Limited (NSE:CROMPTON) 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 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 ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?

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 Crompton Greaves Consumer Electricals:

0.46 = ₹5.2b ÷ (₹23b – ₹11b) (Based on the trailing twelve months to September 2018.)

Therefore, Crompton Greaves Consumer Electricals has an ROCE of 46%.

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Does Crompton Greaves Consumer Electricals Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Crompton Greaves Consumer Electricals’s ROCE is meaningfully better than the 16% average in the Consumer Durables industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Crompton Greaves Consumer Electricals’s ROCE in absolute terms currently looks quite high.

Our data shows that Crompton Greaves Consumer Electricals currently has an ROCE of 46%, compared to its ROCE of 23% 3 years ago. This makes us think the business might be improving.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Crompton Greaves Consumer Electricals.

What Are Current Liabilities, And How Do They Affect Crompton Greaves Consumer Electricals’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Crompton Greaves Consumer Electricals has total liabilities of ₹11b and total assets of ₹23b. As a result, its current liabilities are equal to approximately 48% of its total assets. Crompton Greaves Consumer Electricals has a medium level of current liabilities, boosting its ROCE somewhat.

What We Can Learn From Crompton Greaves Consumer Electricals’s ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. You might be able to find a better buy than Crompton Greaves Consumer Electricals. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Crompton Greaves Consumer Electricals better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.