What Can We Learn From Kirloskar Oil Engines Limited’s (NSE:KIRLOSENG) Investment Returns?

Today we'll look at Kirloskar Oil Engines Limited (NSE:KIRLOSENG) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Kirloskar Oil Engines:

0.14 = ₹2.7b ÷ (₹26b - ₹6.7b) (Based on the trailing twelve months to September 2019.)

So, Kirloskar Oil Engines has an ROCE of 14%.

Check out our latest analysis for Kirloskar Oil Engines

Does Kirloskar Oil Engines Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Kirloskar Oil Engines's ROCE appears to be around the 13% average of the Machinery industry. Aside from the industry comparison, Kirloskar Oil Engines'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.

In our analysis, Kirloskar Oil Engines's ROCE appears to be 14%, compared to 3 years ago, when its ROCE was 11%. This makes us think the business might be improving. You can see in the image below how Kirloskar Oil Engines's ROCE compares to its industry. Click to see more on past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Kirloskar Oil Engines.

How Kirloskar Oil Engines'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.

Kirloskar Oil Engines has total assets of ₹26b and current liabilities of ₹6.7b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Kirloskar Oil Engines's ROCE

If Kirloskar Oil Engines continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Kirloskar Oil Engines. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.