Courtesy/News Source: simplywall.st

Today we’ll evaluate The Indian Hotels Company Limited (NSE:INDHOTEL) to determine whether it could have potential as an investment idea. 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.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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?

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 Indian Hotels:

0.075 = ₹6.5b ÷ (₹110b – ₹23b) (Based on the trailing twelve months to September 2019.)

So, Indian Hotels has an ROCE of 7.5%.

Is Indian Hotels’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Indian Hotels’s ROCE appears to be around the 7.0% average of the Hospitality industry. Independently of how Indian Hotels compares to its industry, its ROCE in absolute terms is low; especially compared to the ~6.5% available in government bonds. Readers may wish to look for more rewarding investments.

You can see in the image below how Indian Hotels’s ROCE compares to its industry. Click to see more on past growth.

NSEI:INDHOTEL Past Revenue and Net Income, January 29th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Indian Hotels.

Indian Hotels’s Current Liabilities And Their Impact On 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.

Indian Hotels has current liabilities of ₹23b and total assets of ₹110b. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

Our Take On Indian Hotels’s ROCE

Indian Hotels has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.

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.

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. Thank you for reading.