Today we'll evaluate Eros International Media Limited (NSE:EROSMEDIA) 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.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Eros International Media:
0.12 = ₹3.3b ÷ (₹41b - ₹12b) (Based on the trailing twelve months to December 2018.)
So, Eros International Media has an ROCE of 12%.
Is Eros International Media's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Eros International Media's ROCE appears to be substantially greater than the 5.1% average in the Entertainment 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. Setting aside the industry comparison for now, Eros International Media's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Eros International Media's current ROCE of 12% is lower than 3 years ago, when the company reported a 19% ROCE. So investors might consider if it has had issues recently.
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. How cyclical is Eros International Media? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Eros International Media'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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Eros International Media has total liabilities of ₹12b and total assets of ₹41b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
Our Take On Eros International Media's ROCE
That said, Eros International Media's ROCE is mediocre, there may be more attractive investments around. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.