In This Article:
Today we'll evaluate Swaraj Engines Limited (NSE:SWARAJENG) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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. 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 Swaraj Engines:
0.41 = ₹1.0b ÷ (₹3.7b - ₹1.2b) (Based on the trailing twelve months to June 2019.)
Therefore, Swaraj Engines has an ROCE of 41%.
See our latest analysis for Swaraj Engines
Is Swaraj Engines's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Swaraj Engines's ROCE appears to be substantially greater than the 13% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Swaraj Engines's ROCE in absolute terms currently looks quite high.
In our analysis, Swaraj Engines's ROCE appears to be 41%, compared to 3 years ago, when its ROCE was 24%. This makes us think the business might be improving. The image below shows how Swaraj Engines's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Swaraj Engines.