Today we’ll look at Hinduja Global Solutions Limited (NSE:HGS) 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. 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 ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Hinduja Global Solutions:

0.11 = ₹2.7b ÷ (₹29b – ₹10b) (Based on the trailing twelve months to September 2018.)

Therefore, Hinduja Global Solutions has an ROCE of 11%.

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Is Hinduja Global Solutions’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Hinduja Global Solutions’s ROCE appears to be around the 14% average of the IT industry. Separate from how Hinduja Global Solutions stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hinduja Global Solutions.

How Hinduja Global Solutions’s Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Hinduja Global Solutions has total liabilities of ₹10b and total assets of ₹29b. Therefore its current liabilities are equivalent to approximately 36% of its total assets. Hinduja Global Solutions’s ROCE is improved somewhat by its moderate amount of current liabilities.

The Bottom Line On Hinduja Global Solutions’s ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: Hinduja Global Solutions may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.