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Today we are going to look at Munjal Showa Limited (NSE:MUNJALSHOW) 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 up, we’ll look at what ROCE is and how we calculate it. 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 measures the ‘return’ (pre-tax profit) a company generates from 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’.
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 Munjal Showa:
0.14 = ₹849m ÷ (₹8.5b – ₹2.6b) (Based on the trailing twelve months to December 2018.)
Therefore, Munjal Showa has an ROCE of 14%.
Check out our latest analysis for Munjal Showa
Is Munjal Showa’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Munjal Showa’s ROCE is fairly close to the Auto Components industry average of 17%. Setting aside the industry comparison for now, Munjal Showa’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.
Munjal Showa’s current ROCE of 14% is lower than its ROCE in the past, which was 20%, 3 years ago. So investors might consider if it has had issues recently.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Munjal Showa? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.