In This Article:
Today we are going to look at Maithan Alloys Limited (NSE:MAITHANALL) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
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. Ultimately, it is a useful but imperfect metric. 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?
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 Maithan Alloys:
0.26 = ₹2.9b ÷ (₹15b - ₹3.7b) (Based on the trailing twelve months to June 2019.)
So, Maithan Alloys has an ROCE of 26%.
See our latest analysis for Maithan Alloys
Is Maithan Alloys's ROCE Good?
One way to assess ROCE is to compare similar companies. Maithan Alloys's ROCE appears to be substantially greater than the 14% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Maithan Alloys's ROCE is currently very good.
The image below shows how Maithan Alloys's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, Maithan Alloys could be considered cyclical. How cyclical is Maithan Alloys? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Maithan Alloys's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.