Today we'll evaluate Spectrum Electrical Industries Limited (NSE:SPECTRUM) 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, we'll go over how we 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.
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. All else being equal, a better business will have a higher ROCE. 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 Spectrum Electrical Industries:
0.13 = ₹122m ÷ (₹1.4b - ₹514m) (Based on the trailing twelve months to March 2019.)
So, Spectrum Electrical Industries has an ROCE of 13%.
View our latest analysis for Spectrum Electrical Industries
Does Spectrum Electrical Industries Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Spectrum Electrical Industries's ROCE appears to be around the 13% average of the Electrical industry. Separate from how Spectrum Electrical Industries stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
We can see that, Spectrum Electrical Industries currently has an ROCE of 13% compared to its ROCE 3 years ago, which was 3.4%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Spectrum Electrical Industries's past growth compares to other companies.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Spectrum Electrical Industries is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.