In order to find most profitable companies in India, the best tool is Return on Capital Employed (ROCE).
Investors can also look into Profit & Loss accounts to check net profit (PAT) levels.
But looking only into ‘net profits’ says less about companies profitability.
It is wiser to look into both balance sheet and earning report to check profitability.
All investors have a common objective of buying stocks of good business. The best business is one that is most profitable.
In financial terms checking ROCE is a excellent check of profitability of a company.
Return on capital employed (ROCE) is expressed as percentage (%) of total tangible capital invested in a business.
There are several advantages of being aware of ROCE of a company (more than just PAT).
Investors can use profitability levels (ROCE, PAT) of one company and compare it with other. Lets take an example company A & B.
The company with higher ROCE will be considered better for investment. Let us see an example:
|Company A||$ 500,000||6%|
|Company B||$ 250,000||12%|
An investor must prefer Company B over A as B’s ROCE is better.
But if one does not know the ROCE concept, then by just looking at PAT, he/she will be tempted to invest in Company A.
The investing logic is simple, a company which has prospects of faster growth must be preferred for investing. Return on capital employed (ROCE) gives us this idea.
It shows us how profitable a company is, and how fast it can grow its profits in times to come.
ROCE measure profitability of a company from point of view of owners. How? Lets see…
Suppose you want to generate annual income of say $10,000.
In order to generate this income there are two possibilities.
- One possibility asks you to invest $100,000 and get return of $10,000/year (RoCE=10%).
- The other possibility asks only $90,000 and provides $10,000/year (RoCE=11.1%).
Which option will you choose?
Its obvious that the second option is more profitable.
ROCE looks at profitability of business from this angle. Profit generated per dollar of invested capital.
$100,000 & $90,000 is called as capital employed and $10,000 is the return on capital employed.
But if ROCE is so effective way to measure profitability of a company, then why lot of investors does not use it?
#1. Measure Profitability of a Company using ROCE
PAT figures are directly available on profit & loss accounts. Just by looking at PAT and Sales Turnover, an investor can quickly guess the PAT Margin.
But the same is not true for RoCE. Return on capital employed (ROCE) needs more manual calculations.
In this article we will see how to measure profitability of company using ROCE.
To buy shares of good business, it is very important to know the ROCE figures.
|Return on Capital Employed (ROCE) = PBIT / Capital Employed|
#1.1 PBIT (Profit Before Interest & Tax)
PBIT can be back calculated from Net Profit (PAT) by adding to it the interest and depreciation.
All three figures PAT, interest & depreciation can be easily obtained form the profit & loss accounts of company.
In order to compare the profitability of two companies, it is better to use PBIT instead of PAT.
This is because PBIT brings companies in same platform.
Different companies work in different geographical locations. Working in different locations imposes different interest rates and local tax structures.
Calculation of RoCE using PBIT makes all companies stand on the same ground level for evaluation.
|PBIT = Net Profit (PAT) + Interest + Tax|
#1.2 Capital Employed
Employed capital is that fund that a company is using to fund its operations.
Company generates its funds in two ways:
- From shareholders equity and
- Debt it takes from banks etc.
Idea of measuring profitability of company using ROCE is to know how much profit a company can generate from its capital employed.
Good companies will generate more profits, per dollar of invested capital, as compared to its rivals.
|Capital Employed = Shareholders Equity + Debt|
The invested capital creates profits (PAT).
The objective of any company is to generate maximum profits with minimum capital investment.
Lets take an example:
|PAT||Capital Employed||Profitability (ROCE)|
|Company C||$ 500,000||$ 8,333,333||6%|
|Company D||$ 500,000||$ 4,166,666||12%|
An investor would like invest in company D over C because it generates the same level of profits (PAT) from less capital employed.
This shows that the company D is more profitable than company C.
Most Profitable Companies in India 2018
(Updated as on April’2018)
- Tata Consultancy Services Ltd.
- Hindustan Zinc Ltd.
- Tata Communications Ltd.
- HCL Technologies Ltd.
- Castrol India Ltd.
- Oracle Financial Serv.
- Ajanta Pharma Ltd.
- Larsen & Toubro Infotech Ltd.
- Zee Entertainment Ent.
- Bajaj Auto Ltd
Check this link to find details of 25 most profitable companies in India
Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyse all securities before investing in one.