Here’s why Aster DM Healthcare Limited’s (NSE:ASTERDM) Returns On Capital Matters So Much

Jonathon Baker

Tue, Feb 5, 2019, 5:05 PM

Today we’ll evaluate Aster DM Healthcare Limited (NSE:ASTERDM) 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. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

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. 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 Aster DM Healthcare:

0.073 = ₹3.2b ÷ (₹85b – ₹27b) (Based on the trailing twelve months to September 2018.)

Therefore, Aster DM Healthcare has an ROCE of 7.3%.

View our latest analysis for Aster DM Healthcare

Is Aster DM Healthcare’s ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, Aster DM Healthcare’s ROCE appears meaningfully below the 12% average reported by the Healthcare industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Aster DM Healthcare compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. It is likely that there are more attractive prospects out there.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.