Today we are going to look at SPML Infra Limited (NSE:SPMLINFRA) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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'.
So, How Do We Calculate ROCE?
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 SPML Infra:
0.11 = ₹1.5b ÷ (₹35b - ₹20b) (Based on the trailing twelve months to September 2019.)
Therefore, SPML Infra has an ROCE of 11%.
Does SPML Infra Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, SPML Infra's ROCE appears meaningfully below the 14% average reported by the Construction industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how SPML Infra compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. It is likely that there are more attractive prospects out there.
We can see that, SPML Infra currently has an ROCE of 11%, less than the 15% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how SPML Infra's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. You can check if SPML Infra has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do SPML Infra's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
SPML Infra has total assets of ₹35b and current liabilities of ₹20b. Therefore its current liabilities are equivalent to approximately 58% of its total assets. Current liabilities of this level result in a meaningful boost to SPML Infra's ROCE.
Our Take On SPML Infra's ROCE
SPML Infra's ROCE in absolute terms is poor, and there are likely better investment prospects out there. Of course, you might also be able to find a better stock than SPML Infra. 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.
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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.