Today we'll evaluate NOCIL Limited (NSE:NOCIL) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for NOCIL:

0.16 = ₹2.1b ÷ (₹15b - ₹1.5b) (Based on the trailing twelve months to September 2019.)

Therefore, NOCIL has an ROCE of 16%.

See our latest analysis for NOCIL

Does NOCIL Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see NOCIL's ROCE is around the 17% average reported by the Chemicals industry. Independently of how NOCIL compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

The image below shows how NOCIL's ROCE compares to its industry, and you can click it to see more detail on its past growth.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for NOCIL.

What Are Current Liabilities, And How Do They Affect NOCIL'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.

NOCIL has total assets of ₹15b and current liabilities of ₹1.5b. Therefore its current liabilities are equivalent to approximately 10.0% of its total assets. Low current liabilities have only a minimal impact on NOCIL's ROCE, making its decent returns more credible.

What We Can Learn From NOCIL's ROCE

If NOCIL can continue reinvesting in its business, it could be an attractive prospect. There might be better investments than NOCIL out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.