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Today we are going to look at Sundaram Finance Holdings Limited (NSE:SUNDARMHLD) to see whether it might be an attractive investment prospect. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.’
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 Sundaram Finance Holdings:
0.025 = ₹211m ÷ (₹8.4b – ₹50m) (Based on the trailing twelve months to March 2018.)
So, Sundaram Finance Holdings has an ROCE of 2.5%.
Check out our latest analysis for Sundaram Finance Holdings
Is Sundaram Finance Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Sundaram Finance Holdings’s ROCE appears meaningfully below the 17% average reported by the Auto Components industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Sundaram Finance Holdings’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. If Sundaram Finance Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.