In This Article:
Today we’ll evaluate Indian Terrain Fashions Limited (NSE:INDTERRAIN) 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, we’ll go over how we 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 measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?
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 Indian Terrain Fashions:
0.20 = ₹436m ÷ (₹3.7b – ₹1.3b) (Based on the trailing twelve months to December 2018.)
Therefore, Indian Terrain Fashions has an ROCE of 20%.
Check out our latest analysis for Indian Terrain Fashions
Does Indian Terrain Fashions Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Indian Terrain Fashions’s ROCE is meaningfully better than the 11% average in the Luxury industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Indian Terrain Fashions’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
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. ROCE is only a point-in-time measure. You can check if Indian Terrain Fashions has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Indian Terrain Fashions’s 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.