Are ITC Limited’s (NSE:ITC) Returns On Investment Worth Your While?
Today we'll look at ITC Limited (NSE:ITC) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 ITC:
0.28 = ₹175b ÷ (₹718b - ₹100b) (Based on the trailing twelve months to June 2019.)
So, ITC has an ROCE of 28%.
Check out our latest analysis for ITC
Does ITC Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see ITC's ROCE is around the 28% average reported by the Tobacco industry. Regardless of the industry comparison, in absolute terms, ITC's ROCE currently appears to be excellent.
You can click on the image below to see (in greater detail) how ITC'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. Since the future is so important for investors, you should check out our free report on analyst forecasts for ITC.
Do ITC's Current Liabilities Skew 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.
ITC has total liabilities of ₹100b and total assets of ₹718b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From ITC's ROCE
This is good to see, and with such a high ROCE, ITC may be worth a closer look. There might be better investments than ITC out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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.
