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Today we are going to look at MMP Industries Limited (NSE:MMP) to see whether it might be an attractive investment prospect. 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. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 MMP Industries:

0.25 = ₹276m ÷ (₹1.6b – ₹504m) (Based on the trailing twelve months to March 2018.)

Therefore, MMP Industries has an ROCE of 25%.

View our latest analysis for MMP Industries

Does MMP Industries Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. MMP Industries’s ROCE appears to be substantially greater than the 16% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from MMP Industries’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

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. We note MMP Industries could be considered a cyclical business. You can check if MMP Industries has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

MMP Industries’s Current Liabilities And Their Impact On 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.