Today we’ll evaluate HBL Power Systems Limited (NSE:HBLPOWER) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 HBL Power Systems:
0.10 = ₹798m ÷ (₹13b – ₹5.7b) (Based on the trailing twelve months to March 2018.)
So, HBL Power Systems has an ROCE of 10%.
View our latest analysis for HBL Power Systems
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Is HBL Power Systems’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, HBL Power Systems’s ROCE appears meaningfully below the 15% average reported by the Electrical industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how HBL Power 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.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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 HBL Power Systems? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.