Should You Like Voltas Limited’s (NSE:VOLTAS) High Return On Capital Employed?
Today we are going to look at Voltas Limited (NSE:VOLTAS) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Voltas:
0.18 = ₹6.9b ÷ (₹74b – ₹33b) (Based on the trailing twelve months to September 2018.)
So, Voltas has an ROCE of 18%.
See our latest analysis for Voltas
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Does Voltas Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Voltas’s ROCE is meaningfully higher than the 12% average in the Construction 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. Independently of how Voltas compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Voltas.
What Are Current Liabilities, And How Do They Affect Voltas’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Voltas has total liabilities of ₹33b and total assets of ₹74b. Therefore its current liabilities are equivalent to approximately 45% of its total assets. With this level of current liabilities, Voltas’s ROCE is boosted somewhat.
The Bottom Line On Voltas’s ROCE
Voltas’s ROCE does look good, but the level of current liabilities also contribute to that. But note: Voltas may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
