Are Precision Wires India Ltd.’s (NSE:PRECWIRE) High Returns Really That Great?

Simply Wall St

Today we are going to look at Precision Wires India Ltd. (NSE:PRECWIRE) to see whether it might be an attractive investment prospect. 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. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

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

ROCE measures the amount of pre-tax profits a company can generate from the 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Precision Wires India:

0.31 = ₹819m ÷ (₹5.9b – ₹3.3b) (Based on the trailing twelve months to December 2018.)

So, Precision Wires India has an ROCE of 31%.

View our latest analysis for Precision Wires India

Is Precision Wires India’s ROCE Good?

One way to assess ROCE is to compare similar companies. Precision Wires India’s ROCE appears to be substantially greater than the 15% average in the Electrical industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Precision Wires India’s ROCE is currently very good.

As we can see, Precision Wires India currently has an ROCE of 31% compared to its ROCE 3 years ago, which was 16%. This makes us think about whether the company has been reinvesting shrewdly.

NSEI:PRECWIRE Past Revenue and Net Income, March 19th 2019

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Precision Wires India’s Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Precision Wires India has total assets of ₹5.9b and current liabilities of ₹3.3b. Therefore its current liabilities are equivalent to approximately 55% of its total assets. While a high level of current liabilities boosts its ROCE, Precision Wires India’s returns are still very good.

What We Can Learn From Precision Wires India’s ROCE

So we would be interested in doing more research here — there may be an opportunity! Of course you might be able to find a better stock than Precision Wires India. So you may wish to see this free collection of other companies that have grown earnings strongly.

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 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.