In This Article:
Today we'll look at Ramkrishna Forgings Limited (NSE:RKFORGE) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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.
How Do You Calculate Return On Capital Employed?
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 Ramkrishna Forgings:
0.17 = ₹2.4b ÷ (₹22b - ₹7.9b) (Based on the trailing twelve months to June 2019.)
Therefore, Ramkrishna Forgings has an ROCE of 17%.
View our latest analysis for Ramkrishna Forgings
Is Ramkrishna Forgings's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Ramkrishna Forgings's ROCE is meaningfully better than the 14% 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 Ramkrishna Forgings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Ramkrishna Forgings's ROCE appears to be 17%, compared to 3 years ago, when its ROCE was 11%. This makes us think the business might be improving. You can see in the image below how Ramkrishna Forgings's ROCE compares to its industry. Click to see more on past growth.
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, after all, simply a snap shot of a single year. We note Ramkrishna Forgings could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.