In This Article:
Today we'll evaluate Prakash Pipes Limited (NSE:PPL) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Prakash Pipes:
0.34 = ₹378m ÷ (₹1.4b - ₹290m) (Based on the trailing twelve months to June 2019.)
Therefore, Prakash Pipes has an ROCE of 34%.
Check out our latest analysis for Prakash Pipes
Does Prakash Pipes Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Prakash Pipes's ROCE is meaningfully better than the 14% average in the Building 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. Regardless of the industry comparison, in absolute terms, Prakash Pipes's ROCE currently appears to be excellent.
The image below shows how Prakash Pipes's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Prakash Pipes? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Prakash Pipes's Current Liabilities Skew 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.