In This Article:
Today we'll look at Deepak Nitrite Limited (NSE:DEEPAKNTR) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Deepak Nitrite:
0.26 = ₹5.3b ÷ (₹29b - ₹8.8b) (Based on the trailing twelve months to June 2019.)
Therefore, Deepak Nitrite has an ROCE of 26%.
View our latest analysis for Deepak Nitrite
Does Deepak Nitrite Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Deepak Nitrite's ROCE appears to be substantially greater than the 17% average in the Chemicals industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Deepak Nitrite's ROCE in absolute terms currently looks quite high.
We can see that, Deepak Nitrite currently has an ROCE of 26% compared to its ROCE 3 years ago, which was 17%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Deepak Nitrite's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Deepak Nitrite's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counter this, investors can check if a company has high current liabilities relative to total assets.