In This Article:
Today we'll evaluate 20 Microns Limited (NSE:20MICRONS) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.
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 20 Microns:
0.25 = ₹609m ÷ (₹4.0b - ₹1.6b) (Based on the trailing twelve months to June 2019.)
So, 20 Microns has an ROCE of 25%.
Check out our latest analysis for 20 Microns
Does 20 Microns Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that 20 Microns's ROCE is meaningfully better than the 18% average in the Chemicals 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. Separate from 20 Microns's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how 20 Microns's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is 20 Microns? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How 20 Microns's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.