Thread by @ShubhamBiswal18

For Part 2 into understanding roce/roic of a business - roce/roic although by general definition sounds very simple, I.e the returns a company is generating on its invested capital, sounds very simple prima facie and a bit similar to ebit/op margins. However - contd.

https://twitter.com/ShubhamBiswal18/status/1530495424834207745

Remember this "capital employed" Is the money employed for buying the raw materials, for funding capex growth etc. So in a way this doesn't show much about the value addition that a company does to its raw materials (which operating/ebit margins does).

So roce is a measure of EFFICIENCY of a business and it gives idea about both the nature of product AND also how well is the company able to deploy its capital right to sell MORE OF IT. I know sounds a bit confusing but lets do the dupont (I.e breakdown of roce into simple parts

Let's just stick with the turnover part and the earnings as% of sales (which is nothing but ebit/opm discussed in the last tweet) so roce not only contains the ebit margin but also the "turnover" Part - which is our key focus here. Let me simplify it even further contd.

Roce is return on capital employed. I.e EBIT/CAPITAL EMPLOYED. But capital employed is nothing but money that was invested from {(reserves+share capital) + debt} i.e (internal accruals + debt funded capital) - so roce is nothing but Return on MONEY INVESTED. That's all you have

To remember - now let's go deeper roce is ebit/CE which can be mathematically written as (EBIT/SALES) * (SALES/CE). Sales cancels each other and we are left with ebit/CE right where we started. Ebit/sales has already been discussed as operating margins, now our focus is on

SALES/CE, which is also known as TURNOVER. In a way just simply understand if CE turnover is high, company uses lesser money to generate HIGHER SALES and vice versa. Let us understand with 2 examples - First is DMART

DMART

Even if DMART is a low operating margin business (7-9%),they have to maintain lowest cost to beat the competition. But look at their roce - double digits (16-25%). How is this possible ? Simple. CE TURNOVER - Understand the business of dmart. Since it buys/sells its

Products in bulk - it can but products on credit at a cheaper price as well! Thus it doesn't have to pump a lot of capital to keep buying new products! In a way it uses its power as a large buyer to make it's business more capital efficient, and thus the double digit ROCES

Second example - APL APOLLO, Which is nothing but a steel converter. Now this is an excercise for you - Look at operating margins and the roce of business and use the same logic as dmart. Hope this helped. Thank you for reading 🙏🏻 do share what you have found.

#investing #roce #learning #capital