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Today we'll look at Arvee Laboratories (India) Ltd. (NSE:ARVEE) and reflect on its potential as an investment. 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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. 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 Arvee Laboratories (India):
0.22 = ₹50m ÷ (₹441m - ₹213m) (Based on the trailing twelve months to March 2018.)
So, Arvee Laboratories (India) has an ROCE of 22%.
View our latest analysis for Arvee Laboratories (India)
Is Arvee Laboratories (India)'s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Arvee Laboratories (India)'s ROCE is meaningfully higher than the 17% average in the Chemicals industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Arvee Laboratories (India)'s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Arvee Laboratories (India) currently has an ROCE of 22% compared to its ROCE 3 years ago, which was 7.9%. This makes us think the business might be improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Arvee Laboratories (India) has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.