Don’t Buy Aditya Birla Fashion and Retail Limited (NSE:ABFRL) Until You Understand Its ROCE

Today we are going to look at Aditya Birla Fashion and Retail Limited (NSE:ABFRL) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. 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 Aditya Birla Fashion and Retail:

0.14 = ₹3.4b ÷ (₹66b - ₹42b) (Based on the trailing twelve months to June 2019.)

So, Aditya Birla Fashion and Retail has an ROCE of 14%.

See our latest analysis for Aditya Birla Fashion and Retail

Does Aditya Birla Fashion and Retail Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Aditya Birla Fashion and Retail's ROCE appears to be around the 12% average of the Luxury industry. Setting aside the industry comparison for now, Aditya Birla Fashion and Retail'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.

Our data shows that Aditya Birla Fashion and Retail currently has an ROCE of 14%, compared to its ROCE of 6.0% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Aditya Birla Fashion and Retail's past growth compares to other companies.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Aditya Birla Fashion and Retail.

What Are Current Liabilities, And How Do They Affect Aditya Birla Fashion and Retail's 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Aditya Birla Fashion and Retail has total assets of ₹66b and current liabilities of ₹42b. As a result, its current liabilities are equal to approximately 63% of its total assets. With a high level of current liabilities, Aditya Birla Fashion and Retail will experience a boost to its ROCE.

The Bottom Line On Aditya Birla Fashion and Retail's ROCE

Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Aditya Birla Fashion and Retail better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.