Today we'll evaluate Shree Ram Proteins Limited (NSE:SRPL) to determine whether it could have potential as an investment idea. 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.
First of all, we'll work out how to calculate ROCE. 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 '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. In brief, it is a useful tool, but it is not without drawbacks. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Shree Ram Proteins:
0.15 = ₹79m ÷ (₹968m - ₹430m) (Based on the trailing twelve months to March 2019.)
So, Shree Ram Proteins has an ROCE of 15%.
See our latest analysis for Shree Ram Proteins
Is Shree Ram Proteins's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Shree Ram Proteins's ROCE is meaningfully higher than the 12% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how Shree Ram Proteins 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.
You can click on the image below to see (in greater detail) how Shree Ram Proteins'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Shree Ram Proteins has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Shree Ram Proteins's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.