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Today we’ll evaluate KDDL Limited (NSE:KDDL) to determine whether it could have potential as an investment idea. 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. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.

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

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.’

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 KDDL:

0.20 = ₹328m ÷ (₹4.7b – ₹2.0b) (Based on the trailing twelve months to December 2018.)

Therefore, KDDL has an ROCE of 20%.

View our latest analysis for KDDL

Does KDDL Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. KDDL’s ROCE appears to be substantially greater than the 11% average in the Luxury 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 KDDL compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. How cyclical is KDDL? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do KDDL’s Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

KDDL has total liabilities of ₹2.0b and total assets of ₹4.7b. Therefore its current liabilities are equivalent to approximately 43% of its total assets. KDDL has a medium level of current liabilities, which would boost the ROCE.

Our Take On KDDL’s ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. But note: KDDL may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.