Today we’ll evaluate Hind Rectifiers Limited (NSE:HIRECT) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from 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 Hind Rectifiers:

0.19 = ₹77m ÷ (₹1.6b – ₹741m) (Based on the trailing twelve months to September 2018.)

So, Hind Rectifiers has an ROCE of 19%.

View our latest analysis for Hind Rectifiers

Does Hind Rectifiers Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Hind Rectifiers’s ROCE is meaningfully higher than the 15% average in the Electrical industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Hind Rectifiers compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Hind Rectifiers has an ROCE of 19%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. How cyclical is Hind Rectifiers? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Hind Rectifiers’s Current Liabilities And Their Impact On 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.

Hind Rectifiers has total liabilities of ₹741m and total assets of ₹1.6b. As a result, its current liabilities are equal to approximately 46% of its total assets. Hind Rectifiers has a medium level of current liabilities, which would boost the ROCE.

The Bottom Line On Hind Rectifiers’s ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. But note: Hind Rectifiers may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.