Today we'll evaluate Cimmco Limited (NSE:CIMMCO) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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?
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 Cimmco:
0.062 = ₹196m ÷ (₹4.8b - ₹1.7b) (Based on the trailing twelve months to June 2019.)
So, Cimmco has an ROCE of 6.2%.
View our latest analysis for Cimmco
Does Cimmco Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Cimmco's ROCE appears meaningfully below the 13% average reported by the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Cimmco 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.
Cimmco delivered an ROCE of 6.2%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Cimmco's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Cimmco? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.