Today we are going to look at Thejo Engineering Limited (NSE:THEJO) to see whether it might be an attractive investment prospect. 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.
What is 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. 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.’
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 Thejo Engineering:
0.28 = ₹224m ÷ (₹1.5b – ₹715m) (Based on the trailing twelve months to March 2018.)
Therefore, Thejo Engineering has an ROCE of 28%.
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Does Thejo Engineering Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Thejo Engineering’s ROCE is meaningfully higher than the 15% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Thejo Engineering’s ROCE is currently very good.
Our data shows that Thejo Engineering currently has an ROCE of 28%, compared to its ROCE of 9.2% 3 years ago. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Thejo Engineering? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Thejo Engineering’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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Thejo Engineering has total assets of ₹1.5b and current liabilities of ₹715m. As a result, its current liabilities are equal to approximately 47% of its total assets. A medium level of current liabilities boosts Thejo Engineering’s ROCE somewhat.
What We Can Learn From Thejo Engineering’s ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than Thejo Engineering out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at [email protected]. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.