Does Aarvee Denims and Exports Limited (NSE:AARVEEDEN) Create Value For Shareholders?

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we'll evaluate Aarvee Denims and Exports Limited (NSE:AARVEEDEN) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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.'

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 Aarvee Denims and Exports:

0.12 = ₹499m ÷ (₹9.2b - ₹5.1b) (Based on the trailing twelve months to March 2018.)

Therefore, Aarvee Denims and Exports has an ROCE of 12%.

Check out our latest analysis for Aarvee Denims and Exports

Does Aarvee Denims and Exports Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Aarvee Denims and Exports's ROCE is around the 11% average reported by the Luxury industry. Separate from how Aarvee Denims and Exports stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Our data shows that Aarvee Denims and Exports currently has an ROCE of 12%, compared to its ROCE of 7.0% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Aarvee Denims and Exports? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Aarvee Denims and Exports's Current Liabilities And Their Impact On Its 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 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.

Aarvee Denims and Exports has total assets of ₹9.2b and current liabilities of ₹5.1b. Therefore its current liabilities are equivalent to approximately 56% of its total assets. With a high level of current liabilities, Aarvee Denims and Exports will experience a boost to its ROCE.

Our Take On Aarvee Denims and Exports's ROCE

Even so, the company reports a mediocre ROCE, and there may be better investments out there. 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 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.