What is Return On Capital Employed ( ROCE ) and what you should derive from it for value picking?

A ratio that indicates the efficiency and profitability of a company's capital investments.

                                 Earnings

  ROCE =    -------------------------------------------      X 100    

                          Capital Employed

•         The numerator is Earnings before Interest & Tax. It is net revenue after all the operating expenses are deducted

•         The denominator (capital employed) denotes sources of funds such as equity and short-term debt financing which is used for the day-to-day running of the company. Capital Employed is represented as total assets minus current liabilities. In other words, it is the value of the assets that contribute to a company’s ability to generate revenue

ROCE value from Finance sheet tells us …

•          It is a useful measurement for comparing the relative profitability of companies

•          ROCE does not consider profit margins (percentage of profit) alone but also considers the amount of capital utilized for those profits to happen

•          It is possible that a company’s profit margin is higher than that of another company, but its ability to get better return on its capital may be lower

•          ROCE should always be higher than the cost of borrowing

•          An increase in the company’s borrowings will put an additional debt burden on the company and will reduce shareholders’ earnings

•          So, as a thumb rule, a  ROCE of 20% or more is considered very good

•          If a company has a low ROCE, it means that it is using its resources inefficiently, even if its profit margin is high.

Drawbacks of ROCE

•         The main drawback of ROCE is that it measures return against the book value of assets in the business. As these are depreciated the ROCE will increase even though cash flow has remained the same. Thus, older businesses with depreciated assets will tend to have higher ROCE than newer, possibly better businesses. In addition, while cash flow is affected by inflation, the book value of assets is not. Consequently revenues increase with inflation while capital employed generally does not (as the book value of assets is not affected by inflation).

What are ESOPS , and why your Employer issue them ?

An Employee Stock Option (ESOP) Plan is when the company offers its shares to the employees. An ESOP is nothing but an option to buy the company's share at a certain price. This could either be at the market price (price of the share currently listed on the stock exchange), or at a preferential price (price lower than the current market price). If the firm has not yet gone public (shares are not listed on any stock exchange), it could be at whatever price the management fixes.

2. Why your Employer offer an ESOP to you?

Retention is the pre-dominant objective. The ESOP trend started somewhere in the late 1990s, when we also saw the emergence of new entrepreneurs and many venture-funded companies. In many cases, there were also management buyouts. Essentially, the investors hired key executives and in order to get them equity in the company, ESOP was the ideal way, wherein they did not put in money initially but they did get options that were at a discount. So they could get shares in the company at a lower price than the investors. For established companies, retention is the main objective and for start-ups it is a way to get a management team in place. It is also something like a joining bonus in case the employee who joins had stock options in his previous company. You have to compensate him, because he foregoes the gains he made there. Just like you match the salary, you also match the stock options.

Typically, retention works where the unvested options are more than the vested options. Employees should have something to look forward to. If ESOP is like a one-time grant, after two years when the options vest, there is nothing that the employee will look forward to. Companies offer their employees shares because it is considered that having a stake in the company would increase loyalty and motivation substantially.

What are the tax implications of ESOPs?

FBT as a tax is on the company, so the responsibility is on the company to pay but specific with ESOPs, the law also gives authority to the company to pass it on. So in our experience almost 100% of the companies have passed on the tax impact to their employees. Before FBT came in, the ESOP gains were virtually tax-free. The kind of gains employees were making was very noticeable, so the tax was long overdue. But the real impact of FBT is much less than 33%