Today we are going to look at Siyaram Silk Mills Limited (NSE:SIYSIL) 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.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. 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'.

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 Siyaram Silk Mills:

0.21 = ₹2.1b ÷ (₹15b - ₹5.2b) (Based on the trailing twelve months to March 2019.)

So, Siyaram Silk Mills has an ROCE of 21%.

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Is Siyaram Silk Mills's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Siyaram Silk Mills's ROCE is meaningfully higher than the 11% average in the Luxury 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. Regardless of where Siyaram Silk Mills sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Siyaram Silk Mills.

Do Siyaram Silk Mills's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Siyaram Silk Mills has total assets of ₹15b and current liabilities of ₹5.2b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. Siyaram Silk Mills has a medium level of current liabilities, which would boost the ROCE.

The Bottom Line On Siyaram Silk Mills's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Siyaram Silk Mills 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 are like me, then you will not want to miss this free list of growing companies that insiders are 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.