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Today we are going to look at Rane (Madras) Limited (NSE:RML) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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. 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?
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 Rane (Madras):
0.15 = ₹606m ÷ (₹9.7b - ₹5.7b) (Based on the trailing twelve months to December 2018.)
Therefore, Rane (Madras) has an ROCE of 15%.
See our latest analysis for Rane (Madras)
Is Rane (Madras)'s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Rane (Madras)'s ROCE appears to be around the 16% average of the Auto Components industry. Aside from the industry comparison, Rane (Madras)'s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is only a point-in-time measure. If Rane (Madras) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Rane (Madras)'s Current Liabilities And Their Impact On 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.