Today we'll evaluate Kamat Hotels (India) Limited (NSE:KAMATHOTEL) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Kamat Hotels (India):
0.36 = ₹536m ÷ (₹4.8b - ₹3.4b) (Based on the trailing twelve months to March 2019.)
So, Kamat Hotels (India) has an ROCE of 36%.
Does Kamat Hotels (India) Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Kamat Hotels (India)'s ROCE is meaningfully better than the 7.8% average in the Hospitality 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, Kamat Hotels (India)'s ROCE in absolute terms currently looks quite high.
In our analysis, Kamat Hotels (India)'s ROCE appears to be 36%, compared to 3 years ago, when its ROCE was 4.8%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Kamat Hotels (India)'s ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. How cyclical is Kamat Hotels (India)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Kamat Hotels (India)'s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.
Kamat Hotels (India) has total liabilities of ₹3.4b and total assets of ₹4.8b. Therefore its current liabilities are equivalent to approximately 69% of its total assets. Kamat Hotels (India)'s high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Kamat Hotels (India)'s ROCE
So we would be interested in doing more research here -- there may be an opportunity! Kamat Hotels (India) looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.