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Today we'll look at Nahar Poly Films Limited (NSE:NAHARPOLY) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. 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.'
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 Nahar Poly Films:
0.028 = ₹129m ÷ (₹4.7b - ₹106m) (Based on the trailing twelve months to March 2019.)
So, Nahar Poly Films has an ROCE of 2.8%.
Is Nahar Poly Films's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Nahar Poly Films's ROCE is meaningfully below the Chemicals industry average of 17%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Nahar Poly Films's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Nahar Poly Films's current ROCE of 2.8% is lower than its ROCE in the past, which was 9.0%, 3 years ago. This makes us wonder if the business is facing new challenges.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. If Nahar Poly Films is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Nahar Poly Films's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Nahar Poly Films has total liabilities of ₹106m and total assets of ₹4.7b. Therefore its current liabilities are equivalent to approximately 2.3% of its total assets. Nahar Poly Films has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From Nahar Poly Films's ROCE
Nonetheless, there may be better places to invest your capital. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 firstname.lastname@example.org. 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.