Today we'll look at D.P. Wires Limited (NSE:DPWIRES) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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?
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 D.P. Wires:
0.29 = ₹246m ÷ (₹1.3b - ₹428m) (Based on the trailing twelve months to March 2019.)
So, D.P. Wires has an ROCE of 29%.
View our latest analysis for D.P. Wires
Is D.P. Wires's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that D.P. Wires's ROCE is meaningfully better than the 14% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, D.P. Wires's ROCE in absolute terms currently looks quite high.
Our data shows that D.P. Wires currently has an ROCE of 29%, compared to its ROCE of 13% 3 years ago. This makes us wonder if the company is improving. The image below shows how D.P. Wires'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, D.P. Wires could be considered cyclical. You can check if D.P. Wires has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do D.P. Wires's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.