In This Article:
Today we'll evaluate Ramco Systems Limited (NSE:RAMCOSYS) 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?
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 Ramco Systems:
0.077 = ₹459m ÷ (₹8.4b - ₹2.5b) (Based on the trailing twelve months to June 2019.)
So, Ramco Systems has an ROCE of 7.7%.
View our latest analysis for Ramco Systems
Is Ramco Systems's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Ramco Systems's ROCE is meaningfully below the IT industry average of 14%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Ramco Systems stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
You can see in the image below how Ramco Systems's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Ramco Systems? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Ramco Systems's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.