What Can We Make Of E.I.D.- Parry (India) Limited’s (NSE:EIDPARRY) High Return On Capital?

Today we'll look at E.I.D.- Parry (India) Limited (NSE:EIDPARRY) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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.

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 E.I.D.- Parry (India):

0.28 = ₹14b ÷ (₹160b - ₹109b) (Based on the trailing twelve months to June 2019.)

Therefore, E.I.D.- Parry (India) has an ROCE of 28%.

See our latest analysis for E.I.D.- Parry (India)

Does E.I.D.- Parry (India) Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. E.I.D.- Parry (India)'s ROCE appears to be substantially greater than the 17% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, E.I.D.- Parry (India)'s ROCE in absolute terms currently looks quite high.

In our analysis, E.I.D.- Parry (India)'s ROCE appears to be 28%, compared to 3 years ago, when its ROCE was 21%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how E.I.D.- Parry (India)'s past growth compares to other companies.

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. ROCE is, after all, simply a snap shot of a single year. How cyclical is E.I.D.- Parry (India)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect E.I.D.- Parry (India)'s ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

E.I.D.- Parry (India) has total liabilities of ₹109b and total assets of ₹160b. Therefore its current liabilities are equivalent to approximately 68% of its total assets. While a high level of current liabilities boosts its ROCE, E.I.D.- Parry (India)'s returns are still very good.

Our Take On E.I.D.- Parry (India)'s ROCE

So to us, the company is potentially worth investigating further. E.I.D.- Parry (India) shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like E.I.D.- Parry (India) 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.