In This Article:
Today we are going to look at Kothari Products Limited (NSE:KOTHARIPRO) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, 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.
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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Kothari Products:
0.14 = ₹1.6b ÷ (₹36b – ₹24b) (Based on the trailing twelve months to March 2018.)
Therefore, Kothari Products has an ROCE of 14%.
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Is Kothari Products’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Kothari Products’s ROCE appears to be substantially greater than the 6.2% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how Kothari Products stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
As we can see, Kothari Products currently has an ROCE of 14%, less than the 25% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and 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. If Kothari Products is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.