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Today we'll evaluate Pashupati Cotspin Limited (NSE:PASHUPATI) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. In brief, it is a useful tool, but it is not without drawbacks. 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'.
So, How Do We Calculate ROCE?
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 Pashupati Cotspin:
0.17 = ₹308m ÷ (₹2.4b - ₹652m) (Based on the trailing twelve months to March 2019.)
Therefore, Pashupati Cotspin has an ROCE of 17%.
View our latest analysis for Pashupati Cotspin
Does Pashupati Cotspin Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Pashupati Cotspin's ROCE is meaningfully better than the 12% 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 Pashupati Cotspin's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. You can check if Pashupati Cotspin has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Pashupati Cotspin's Current Liabilities Skew 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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.