Blue Star Limited (NSE:BLUESTARCO) Is Employing Capital Very Effectively
Today we'll look at Blue Star Limited (NSE:BLUESTARCO) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Blue Star:
0.29 = ₹2.6b ÷ (₹34b - ₹24b) (Based on the trailing twelve months to June 2019.)
Therefore, Blue Star has an ROCE of 29%.
See our latest analysis for Blue Star
Is Blue Star's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Blue Star's ROCE is meaningfully better than the 15% average in the Building industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Blue Star's ROCE currently appears to be excellent.
You can see in the image below how Blue Star's ROCE compares to its industry. Click to see more on 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Blue Star.
What Are Current Liabilities, And How Do They Affect Blue Star's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Blue Star has total liabilities of ₹24b and total assets of ₹34b. As a result, its current liabilities are equal to approximately 73% of its total assets. Blue Star's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
Our Take On Blue Star's ROCE
So to us, the company is potentially worth investigating further. There might be better investments than Blue Star out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.
