Today we'll look at E2E Networks Limited (NSE:E2E) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?
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 E2E Networks:
0.061 = ₹21m ÷ (₹377m - ₹34m) (Based on the trailing twelve months to March 2019.)
Therefore, E2E Networks has an ROCE of 6.1%.
View our latest analysis for E2E Networks
Is E2E Networks's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, E2E Networks's ROCE appears to be significantly below the 14% average in the IT industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how E2E Networks compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. It is likely that there are more attractive prospects out there.
E2E Networks's current ROCE of 6.1% is lower than 3 years ago, when the company reported a 40% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how E2E Networks's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is, after all, simply a snap shot of a single year. You can check if E2E Networks has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.