Today we’ll evaluate Shree Rama Multi-Tech Limited (NSE:SHREERAMA) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 Shree Rama Multi-Tech:
0.079 = ₹83m ÷ (₹1.3b – ₹284m) (Based on the trailing twelve months to December 2019.)
Therefore, Shree Rama Multi-Tech has an ROCE of 7.9%.
Is Shree Rama Multi-Tech’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Shree Rama Multi-Tech’s ROCE appears meaningfully below the 15% average reported by the Packaging industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Shree Rama Multi-Tech 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.
Our data shows that Shree Rama Multi-Tech currently has an ROCE of 7.9%, compared to its ROCE of 2.8% 3 years ago. This makes us wonder if the company is improving. The image below shows how Shree Rama Multi-Tech’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is, after all, simply a snap shot of a single year. You can check if Shree Rama Multi-Tech has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Shree Rama Multi-Tech’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Shree Rama Multi-Tech has current liabilities of ₹284m and total assets of ₹1.3b. As a result, its current liabilities are equal to approximately 21% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From Shree Rama Multi-Tech’s ROCE
While that is good to see, Shree Rama Multi-Tech has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than Shree Rama Multi-Tech. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
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