Godawari Power & Ispat Limited (NSE:GPIL) Earns Among The Best Returns In Its Industry

Simply Wall St

Sat, Apr 6, 2019, 7:52 PM

Today we'll evaluate Godawari Power & Ispat Limited (NSE:GPIL) to determine whether it could have potential as an investment idea. 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.

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. Finally, we'll look at how its current liabilities affect 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. 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.'

So, How Do We Calculate ROCE?

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 Godawari Power & Ispat:

0.22 = ₹6.8b ÷ (₹35b - ₹4.5b) (Based on the trailing twelve months to December 2018.)

So, Godawari Power & Ispat has an ROCE of 22%.

See our latest analysis for Godawari Power & Ispat

Does Godawari Power & Ispat Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Godawari Power & Ispat's ROCE appears to be substantially greater than the 16% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Godawari Power & Ispat sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

As we can see, Godawari Power & Ispat currently has an ROCE of 22% compared to its ROCE 3 years ago, which was 4.6%. This makes us think the business might be improving.

NSEI:GPIL Past Revenue and Net Income, April 7th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Given the industry it operates in, Godawari Power & Ispat could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Godawari Power & Ispat.