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Today we'll look at Agarwal Industrial Corporation Limited (NSE:AGARIND) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 Agarwal Industrial:
0.21 = ₹295m ÷ (₹2.3b - ₹842m) (Based on the trailing twelve months to March 2019.)
Therefore, Agarwal Industrial has an ROCE of 21%.
View our latest analysis for Agarwal Industrial
Does Agarwal Industrial Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Agarwal Industrial's ROCE is fairly close to the Chemicals industry average of 18%. Independently of how Agarwal Industrial compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. If Agarwal Industrial is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Agarwal Industrial'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. 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.