Today we’ll look at Sanginita Chemicals Limited (NSE:SANGINITA) 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 Sanginita Chemicals:
0.24 = ₹76m ÷ (₹609m – ₹289m) (Based on the trailing twelve months to March 2018.)
So, Sanginita Chemicals has an ROCE of 24%.
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Does Sanginita Chemicals Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Sanginita Chemicals’s ROCE appears to be substantially greater than the 17% average in the Chemicals industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Sanginita Chemicals sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Sanginita Chemicals has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Sanginita Chemicals’s Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.