What Is Return on Capital Employed (ROCE) In Stock Market?

What Is Return on Capital Employed (ROCE) In Stock market?

As the name suggests, Return on Capital employed (ROCE) helps in measuring how efficiently a company make use of all available capital to generate additional profits. In other words ROCE is one of the financial ratio helps in determining the profitability of any company.

It indicates the company’s profitability, taking into consideration the overall capital it employs. Keep in mind, Overall capital includes both equity and debt (both long term and short term). Hence it provides a better indication of financial performance for companies with significant debt.

Keep in mind higher the Return on Capital Employed (ROCE) better it is for the company. A high ROCE is, therefore, a sign of a successful growth for any company.

Needless to say ROCE is compared with the other companies in the same industry (Peers) and is also observed over a long time frame. That is to say look for atleast last 5 year ROCE to better check the consistency for any company.

How To Calculate Return on Capital Employed (ROCE)?

The formula use to calculate Return on Capital Employed (ROCE) is given below:

ROCE = [Profit before Interest & Taxes (PBIT) / Overall Capital Employed]

In above equation, Overall Capital Employed = Short term Debt + Long term Debt + Shareholder Equity.

While mentioning capital employed, You have to remember the two main ways of financing a business: by acquiring debt and by selling pieces of the ownership of the company (selling shares). Thus, the capital employed considers equity and liabilities.

Just to let you know PBIT are accessible in Profit and Loss statement where as liabilities (Long and Short) is in balance sheet both can be found in any companies annual report.

Let us understand how to calculate ROCE through a simple example,

For understanding purpose I have taken Tata Motors Limited (TML) Annual report, you can download Tata Motors Limited annual report here or even can get it from its website.

Standalone Financial statements represent the company’s standalone numbers/ financials and do not include its subsidiaries’ financials.

Whereas, the consolidated numbers include the companies (i.e. Standalone financials) and its subsidiaries financial statements.

Hence you should look through the consolidated financial statements as it represent the company’s financial position better.

Let us look at the P&L statement given below (this is half part covering only Profit Before Tax) of Tata Motors Limited (TML).

As you can see from the snapshot above, PBIT i.e. profit before income and tax for TATA Motors for FY-21 is Rs.(10,474.28). FYI, the number in bracket are negative.

Now, coming back to overall capital employed we have to check the liabilities side of the balance sheet of TML, check out the the below image to understand better:

As you can see in above balance sheet statement under equity and liabilities section there is Total Equity is Rs.56,820.21, where as under non current liabilities (Long term debt) Borrowing is of Rs.93,112.77 and current liabilities i.e. short term debt borrowing is of Rs.21,662.79.

As we know the equation to calculate the overall capital employed

Overall Capital Employed = Short term Debt + Long term Debt + Equity

=93,112.77+56,820.21+21,662.79

=Rs.1,71,595.77

ROCE = [Profit before Interest & Taxes (PBIT) / Overall Capital Employed]

=-10,474.28/1,71,595.77

ROCE = -6.10%

This means TML has a negative ROCE and they are not able to create returns from its capital for the company for FY20-21, moreover pandemic added the fuel required fuel to skew it down the stocks to new low level last year, although it have regained much now due to the last half year performance.

However as said above do look for last few year data to get the correct picture and also know the same about the peers. In the case of TML, it would be Maruti and Mahindra. Also do checkout the quarterly reports to stand at better position while investing.

So checkout their respective ROCE, you can either calculate the same from its AR or can used the data which is available on any stock analysis websites.

But remember, doing it from AR will be more good as sometime you will find the data on certain website mismatched.

Also, keep in mind higher the Return on Capital Employed (ROCE) better it is for the company. A higher ROCE shows a higher percentage of the company’s value can ultimately be returned as profit to stockholders.

I hope now you have the basic understanding of what is ROCE in stock market and how it is calculated. 

Do checkout some of the other very important financial ratios for better investing decisions such as how to calculate Return on Asset (ROA) and Return on Equity (ROE).