Why Narayana Hrudayalaya Limited’s (NSE:NH) Return On Capital Employed Might Be A Concern

Today we are going to look at Narayana Hrudayalaya Limited (NSE:NH) 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 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.

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. 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.

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 Narayana Hrudayalaya:

0.099 = ₹2.1b ÷ (₹26b - ₹5.1b) (Based on the trailing twelve months to June 2019.)

Therefore, Narayana Hrudayalaya has an ROCE of 9.9%.

View our latest analysis for Narayana Hrudayalaya

Does Narayana Hrudayalaya Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Narayana Hrudayalaya's ROCE appears meaningfully below the 18% average reported by the Healthcare industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Narayana Hrudayalaya stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

The image below shows how Narayana Hrudayalaya's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NSEI:NH Past Revenue and Net Income, November 5th 2019
NSEI:NH Past Revenue and Net Income, November 5th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Narayana Hrudayalaya.

How Narayana Hrudayalaya's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Narayana Hrudayalaya has total assets of ₹26b and current liabilities of ₹5.1b. As a result, its current liabilities are equal to approximately 19% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

What We Can Learn From Narayana Hrudayalaya's ROCE

Narayana Hrudayalaya has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Narayana Hrudayalaya. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Narayana Hrudayalaya better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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