Today we'll evaluate SoftTech Engineers Limited (NSE:SOFTTECH) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 SoftTech Engineers:
0.17 = ₹115m ÷ (₹850m - ₹179m) (Based on the trailing twelve months to March 2019.)
Therefore, SoftTech Engineers has an ROCE of 17%.
View our latest analysis for SoftTech Engineers
Is SoftTech Engineers's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that SoftTech Engineers's ROCE is meaningfully better than the 12% average in the Software 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. Independently of how SoftTech Engineers compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how SoftTech Engineers's past growth compares to other companies.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If SoftTech Engineers is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How SoftTech Engineers's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.