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Today we'll look at Emkay Taps and Cutting Tools Limited (NSE:EMKAYTOOLS) 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, 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.
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. Generally speaking a higher ROCE is better. 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'.
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 Emkay Taps and Cutting Tools:
0.23 = ₹257m ÷ (₹1.2b - ₹107m) (Based on the trailing twelve months to March 2019.)
So, Emkay Taps and Cutting Tools has an ROCE of 23%.
Check out our latest analysis for Emkay Taps and Cutting Tools
Does Emkay Taps and Cutting Tools Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Emkay Taps and Cutting Tools's ROCE appears to be substantially greater than the 13% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Emkay Taps and Cutting Tools compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 Emkay Taps and Cutting Tools is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Emkay Taps and Cutting Tools's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.