Today we’ll evaluate Bhandari Hosiery Exports Limited (NSE:BHANDHOS) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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. 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. 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 Bhandari Hosiery Exports:

0.15 = ₹133m ÷ (₹1.7b – ₹713m) (Based on the trailing twelve months to September 2018.)

Therefore, Bhandari Hosiery Exports has an ROCE of 15%.

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Does Bhandari Hosiery Exports Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Bhandari Hosiery Exports’s ROCE appears to be substantially greater than the 11% average in the Luxury 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. Aside from the industry comparison, Bhandari Hosiery Exports’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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, after all, simply a snap shot of a single year. You can check if Bhandari Hosiery Exports has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Bhandari Hosiery Exports’s Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Bhandari Hosiery Exports has total liabilities of ₹713m and total assets of ₹1.7b. Therefore its current liabilities are equivalent to approximately 42% of its total assets. Bhandari Hosiery Exports has a medium level of current liabilities, which would boost its ROCE somewhat.

The Bottom Line On Bhandari Hosiery Exports’s ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. But note: Bhandari Hosiery Exports 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).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.