EIH Associated Hotels Limited (NSE:EIHAHOTELS) Earns A Nice Return On Capital Employed

Today we'll look at EIH Associated Hotels Limited (NSE:EIHAHOTELS) 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

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

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?

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 EIH Associated Hotels:

0.15 = ₹555m ÷ (₹4.1b - ₹471m) (Based on the trailing twelve months to June 2019.)

So, EIH Associated Hotels has an ROCE of 15%.

Check out our latest analysis for EIH Associated Hotels

Is EIH Associated Hotels's ROCE Good?

One way to assess ROCE is to compare similar companies. EIH Associated Hotels's ROCE appears to be substantially greater than the 8.1% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Aside from the industry comparison, EIH Associated Hotels's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

We can see that, EIH Associated Hotels currently has an ROCE of 15%, less than the 23% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how EIH Associated Hotels's ROCE compares to its industry, and you can click it to see more detail on its past growth.

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How EIH Associated Hotels's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

EIH Associated Hotels has total assets of ₹4.1b and current liabilities of ₹471m. As a result, its current liabilities are equal to approximately 11% 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 EIH Associated Hotels's ROCE

That said, EIH Associated Hotels's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than EIH Associated Hotels. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like EIH Associated Hotels 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.