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Today we’ll look at Sreeleathers Limited (NSE:SREEL) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 Sreeleathers:
0.12 = ₹308m ÷ (₹3.1b – ₹310m) (Based on the trailing twelve months to September 2018.)
So, Sreeleathers has an ROCE of 12%.
View our latest analysis for Sreeleathers
Is Sreeleathers’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Sreeleathers’s ROCE is meaningfully better than the 2.2% average in the Retail Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the industry comparison for now, Sreeleathers’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Our data shows that Sreeleathers currently has an ROCE of 12%, compared to its ROCE of 6.4% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.