In This Article:
Today we'll look at Asahi India Glass Limited (NSE:ASAHIINDIA) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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'.
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 Asahi India Glass:
0.18 = ₹4.1b ÷ (₹37b - ₹14b) (Based on the trailing twelve months to June 2019.)
Therefore, Asahi India Glass has an ROCE of 18%.
Check out our latest analysis for Asahi India Glass
Is Asahi India Glass's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Asahi India Glass's ROCE is around the 15% average reported by the Auto Components industry. Independently of how Asahi India Glass compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Asahi India Glass's current ROCE of 18% is lower than its ROCE in the past, which was 26%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Asahi India Glass's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. How cyclical is Asahi India Glass? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Asahi India Glass's 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.