In This Article:
Today we'll evaluate Chemfab Alkalis Limited (NSE:CHEMFAB) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Chemfab Alkalis:
0.17 = ₹478m ÷ (₹3.2b - ₹366m) (Based on the trailing twelve months to June 2019.)
Therefore, Chemfab Alkalis has an ROCE of 17%.
See our latest analysis for Chemfab Alkalis
Does Chemfab Alkalis Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Chemfab Alkalis's ROCE is fairly close to the Chemicals industry average of 17%. Independently of how Chemfab Alkalis compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Chemfab Alkalis currently has an ROCE of 17%, compared to its ROCE of 0.9% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Chemfab Alkalis'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. ROCE is only a point-in-time measure. You can check if Chemfab Alkalis has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Chemfab Alkalis's Current Liabilities And Their Impact On 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.