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Today we are going to look at Firstsource Solutions Limited (NSE:FSL) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. 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. Generally speaking a higher ROCE is better. 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 Firstsource Solutions:
0.17 = ₹4.6b ÷ (₹37b - ₹8.9b) (Based on the trailing twelve months to March 2019.)
Therefore, Firstsource Solutions has an ROCE of 17%.
View our latest analysis for Firstsource Solutions
Does Firstsource Solutions Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Firstsource Solutions's ROCE appears to be around the 14% average of the IT industry. Separate from Firstsource Solutions's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Firstsource Solutions's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Firstsource Solutions.
Do Firstsource Solutions's Current Liabilities Skew 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.