Today we are going to look at India Motor Parts and Accessories Limited (NSE:IMPAL) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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. 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 India Motor Parts and Accessories:
0.039 = ₹344m ÷ (₹9.6b - ₹676m) (Based on the trailing twelve months to March 2018.)
Therefore, India Motor Parts and Accessories has an ROCE of 3.9%.
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Does India Motor Parts and Accessories Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. India Motor Parts and Accessories's ROCE appears to be substantially greater than the 2.2% average in the Retail Distributors 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 India Motor Parts and Accessories compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. Readers may wish to look for more rewarding investments.
India Motor Parts and Accessories's current ROCE of 3.9% is lower than its ROCE in the past, which was 16%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if India Motor Parts and Accessories has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How India Motor Parts and Accessories'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.
India Motor Parts and Accessories has total liabilities of ₹676m and total assets of ₹9.6b. As a result, its current liabilities are equal to approximately 7.1% of its total assets. With barely any current liabilities, there is minimal impact on India Motor Parts and Accessories's admittedly low ROCE.
The Bottom Line On India Motor Parts and Accessories's ROCE
Nevertheless, there are potentially more attractive companies to invest in. You might be able to find a better investment than India Motor Parts and Accessories. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like India Motor Parts and Accessories better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.