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Today we'll look at The Tata Power Company Limited ( NSE:TATAPOWER ) and reflect on its potential as an investment. 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.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Ultimately, it is a useful but imperfect metric. 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'.
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 Tata Power:
0.073 = ₹40b ÷ (₹842b - ₹287b) (Based on the trailing twelve months to March 2019.)
Therefore, Tata Power has an ROCE of 7.3%.
View our latest analysis for Tata Power
Is Tata Power's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Tata Power's ROCE appears to be around the 8.3% average of the Electric Utilities industry. Putting aside Tata Power's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
Tata Power's current ROCE of 7.3% is lower than its ROCE in the past, which was 13%, 3 years ago. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company .
What Are Current Liabilities, And How Do They Affect Tata Power's 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Tata Power has total liabilities of ₹287b and total assets of ₹842b. Therefore its current liabilities are equivalent to approximately 34% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Tata Power's low ROCE is unappealing.
The Bottom Line On Tata Power's ROCE
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. 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.
