Today we’ll look at Nitiraj Engineers Limited (NSE:NITIRAJ) and reflect on its potential as an investment. 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.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
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 Nitiraj Engineers:
0.069 = ₹42m ÷ (₹641m – ₹30m) (Based on the trailing twelve months to March 2018.)
Therefore, Nitiraj Engineers has an ROCE of 6.9%.
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Is Nitiraj Engineers’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Nitiraj Engineers’s ROCE appears meaningfully below the 9.5% average reported by the Electronic industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Nitiraj Engineers compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. It is likely that there are more attractive prospects out there.
Nitiraj Engineers’s current ROCE of 6.9% is lower than 3 years ago, when the company reported a 19% ROCE. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. If Nitiraj Engineers is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.