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Today we’ll evaluate Shriram EPC Limited (NSE:SHRIRAMEPC) 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.
Firstly, we’ll go over how we calculate ROCE. 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Shriram EPC:
0.017 = ₹98m ÷ (₹30b – ₹13b) (Based on the trailing twelve months to September 2018.)
Therefore, Shriram EPC has an ROCE of 1.7%.
See our latest analysis for Shriram EPC
Does Shriram EPC Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Shriram EPC’s ROCE appears meaningfully below the 12% average reported by the Construction 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 Shriram EPC stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Shriram EPC has an ROCE of 1.7%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Shriram EPC has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.