Are Menon Bearings Limited’s (NSE:MENONBE) High Returns Really That Great?

Today we are going to look at Menon Bearings Limited (NSE:MENONBE) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

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 Menon Bearings:

0.29 = ?349m ÷ (?1.6b - ?363m) (Based on the trailing twelve months to June 2019.)

So, Menon Bearings has an ROCE of 29%.

See our latest analysis for Menon Bearings

Is Menon Bearings's ROCE Good?

One way to assess ROCE is to compare similar companies. Menon Bearings's ROCE appears to be substantially greater than the 15% average in the Auto Components industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Menon Bearings's ROCE currently appears to be excellent.

Menon Bearings's current ROCE of 29% is lower than its ROCE in the past, which was 46%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Menon Bearings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Menon Bearings.

What Are Current Liabilities, And How Do They Affect Menon Bearings'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 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.

Menon Bearings has total liabilities of ?363m and total assets of ?1.6b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

What We Can Learn From Menon Bearings's ROCE

With low current liabilities and a high ROCE, Menon Bearings could be worthy of further investigation. There might be better investments than Menon Bearings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.