In This Article:
Today we are going to look at RITES Limited (NSE:RITES) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 RITES:
0.22 = ₹6.0b ÷ (₹54b - ₹27b) (Based on the trailing twelve months to June 2019.)
Therefore, RITES has an ROCE of 22%.
Check out our latest analysis for RITES
Is RITES's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, RITES's ROCE is meaningfully higher than the 14% average in the Professional Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where RITES sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, RITES's ROCE appears to be 22%, compared to 3 years ago, when its ROCE was 15%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how RITES'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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for RITES.
Do RITES's Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.