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Today we'll look at Rama Steel Tubes Limited (NSE:RAMASTEEL) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the 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. 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?
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 Rama Steel Tubes:
0.13 = ₹137m ÷ (₹2.0b - ₹926m) (Based on the trailing twelve months to March 2019.)
Therefore, Rama Steel Tubes has an ROCE of 13%.
View our latest analysis for Rama Steel Tubes
Does Rama Steel Tubes Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that Rama Steel Tubes's ROCE is fairly close to the Metals and Mining industry average of 14%. Separate from how Rama Steel Tubes stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Rama Steel Tubes's current ROCE of 13% is lower than 3 years ago, when the company reported a 31% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Rama Steel Tubes's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Given the industry it operates in, Rama Steel Tubes could be considered cyclical. If Rama Steel Tubes is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.