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Today we'll evaluate Pearl Global Industries Limited (NSE:PGIL) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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'.
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 Pearl Global Industries:
0.092 = ₹508m ÷ (₹11b - ₹5.1b) (Based on the trailing twelve months to December 2018.)
So, Pearl Global Industries has an ROCE of 9.2%.
See our latest analysis for Pearl Global Industries
Is Pearl Global Industries's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Pearl Global Industries's ROCE is fairly close to the Luxury industry average of 11%. Independently of how Pearl Global Industries compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. Readers may wish to look for more rewarding investments.
As we can see, Pearl Global Industries currently has an ROCE of 9.2%, less than the 13% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Pearl Global Industries? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.