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Today we are going to look at Nandan Denim Limited (NSE:NDL) 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.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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. 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 Nandan Denim:
0.069 = ₹1.1b ÷ (₹13b – ₹4.1b) (Based on the trailing twelve months to December 2018.)
So, Nandan Denim has an ROCE of 6.9%.
Check out our latest analysis for Nandan Denim
Is Nandan Denim’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Nandan Denim’s ROCE appears meaningfully below the 11% average reported by the Luxury industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Nandan Denim stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
As we can see, Nandan Denim currently has an ROCE of 6.9%, less than the 18% it reported 3 years ago. So investors might consider if it has had issues recently.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Nandan Denim is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.