Today we’ll evaluate E2E Networks Limited (NSE:E2E) 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, we’ll go over how we calculate ROCE.
Next, we’ll compare it to others in its industry.
Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
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.
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.’
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 E2E Networks:
0.20 = ₹70m ÷ (₹406m – ₹55m) (Based on the trailing twelve months to September 2018.)
So, E2E Networks has an ROCE of 20%.
Does E2E Networks Have A Good ROCE?
One way to assess ROCE is to compare similar companies.
Using our data, we find that E2E Networks’s ROCE is meaningfully better than the 14% average in the IT industry.
We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies.
Regardless of where E2E Networks sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
E2E Networks’s current ROCE of 20% is lower than 3 years ago, when the company reported a 32% ROCE.
Therefore we wonder if the company is facing new headwinds.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 only a point-in-time measure.
You can check if E2E Networks has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
E2E Networks’s Current Liabilities And Their Impact On 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
E2E Networks has total liabilities of ₹55m and total assets of ₹406m.
As a result, its current liabilities are equal to approximately 13% of its total assets.
Low current liabilities are not boosting the ROCE too much.
What We Can Learn From E2E Networks’s ROCE
Overall, E2E Networks has a decent ROCE and could be worthy of further research.
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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.
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