Today we are going to look at Rico Auto Industries Limited (NSE:RICOAUTO) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 Rico Auto Industries:

0.085 = ₹701m ÷ (₹13b - ₹5.0b) (Based on the trailing twelve months to June 2019.)

So, Rico Auto Industries has an ROCE of 8.5%.

View our latest analysis for Rico Auto Industries

Does Rico Auto Industries Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Rico Auto Industries's ROCE appears to be significantly below the 15% average in the Auto Components industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Rico Auto Industries's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

You can see in the image below how Rico Auto Industries's ROCE compares to its industry. Click to see more on past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Rico Auto Industries.

How Rico Auto Industries's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Rico Auto Industries has total assets of ₹13b and current liabilities of ₹5.0b. Therefore its current liabilities are equivalent to approximately 38% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Rico Auto Industries's ROCE is concerning.

The Bottom Line On Rico Auto Industries's ROCE

So researching other companies may be a better use of your time. You might be able to find a better investment than Rico Auto Industries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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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.