Today we’ll look at Sarveshwar Foods Limited (NSE:SARVESHWAR) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Sarveshwar Foods:
0.24 = ₹351m ÷ (₹4.2b – ₹2.8b) (Based on the trailing twelve months to September 2018.)
So, Sarveshwar Foods has an ROCE of 24%.
Check out our latest analysis for Sarveshwar Foods
Is Sarveshwar Foods’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Sarveshwar Foods’s ROCE appears to be substantially greater than the 13% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Sarveshwar Foods sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Sarveshwar Foods’s current ROCE of 24% is lower than 3 years ago, when the company reported a 39% 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 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 Sarveshwar Foods has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Sarveshwar Foods’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.