Today we'll evaluate Carborundum Universal Limited (NSE:CARBORUNIV) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

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 Carborundum Universal:

0.18 = ₹3.3b ÷ (₹22b - ₹4.0b) (Based on the trailing twelve months to December 2018.)

So, Carborundum Universal has an ROCE of 18%.

See our latest analysis for Carborundum Universal

Is Carborundum Universal's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Carborundum Universal's ROCE is meaningfully higher than the 15% average in the Machinery industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Carborundum Universal compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Carborundum Universal's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Carborundum Universal has total assets of ₹22b and current liabilities of ₹4.0b. As a result, its current liabilities are equal to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On Carborundum Universal's ROCE

With that in mind, Carborundum Universal's ROCE appears pretty good. Carborundum Universal looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like Carborundum Universal better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.