Today we are going to look at Nico Steel Holdings Limited (SGX:5GF) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

So, How Do We Calculate ROCE?

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 Nico Steel Holdings:

0.045 = US$750k ÷ (US$21m - US$4.8m) (Based on the trailing twelve months to February 2019.)

So, Nico Steel Holdings has an ROCE of 4.5%.

See our latest analysis for Nico Steel Holdings

Does Nico Steel Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In this analysis, Nico Steel Holdings's ROCE appears meaningfully below the 9.7% average reported by the Electronic industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Nico Steel Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

Nico Steel Holdings reported an ROCE of 4.5% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Nico Steel Holdings's past growth compares to other companies.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. You can check if Nico Steel Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Nico Steel Holdings's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Nico Steel Holdings has total assets of US$21m and current liabilities of US$4.8m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Nico Steel Holdings's ROCE

That's not a bad thing, however Nico Steel Holdings has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Nico Steel Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.