Today we are going to look at Avenue Supermarts Limited (NSE:DMART) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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 Avenue Supermarts:

0.24 = ₹12b ÷ (₹56b – ₹6.9b) (Based on the trailing twelve months to March 2018.)

Therefore, Avenue Supermarts has an ROCE of 24%.

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Is Avenue Supermarts’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Avenue Supermarts’s ROCE appears to be substantially greater than the 7.7% average in the Consumer Retailing industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Avenue Supermarts compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

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. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Avenue Supermarts’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. 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.

Avenue Supermarts has total liabilities of ₹6.9b and total assets of ₹56b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Avenue Supermarts’s ROCE

With that in mind, Avenue Supermarts’s ROCE appears pretty good. Of course you might be able to find a better stock than Avenue Supermarts. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Avenue Supermarts better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.