Today we'll look at 3i Infotech Limited (NSE:3IINFOTECH) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 3i Infotech:
0.14 = ₹1.7b ÷ (₹15b - ₹3.3b) (Based on the trailing twelve months to September 2019.)
So, 3i Infotech has an ROCE of 14%.
See our latest analysis for 3i Infotech
Is 3i Infotech's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that 3i Infotech's ROCE is fairly close to the Software industry average of 12%. Regardless of where 3i Infotech sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, 3i Infotech currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 4.0%. This makes us wonder if the company is improving. You can see in the image below how 3i Infotech's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. You can check if 3i Infotech has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How 3i Infotech'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 counter this, investors can check if a company has high current liabilities relative to total assets.