Today we are going to look at Skellerup Holdings Limited (NZSE:SKL) 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. 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Skellerup Holdings:

0.16 = NZ$40m ÷ (NZ$275m - NZ$30m) (Based on the trailing twelve months to December 2019.)

Therefore, Skellerup Holdings has an ROCE of 16%.

View our latest analysis for Skellerup Holdings

Does Skellerup Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Skellerup Holdings's ROCE appears to be substantially greater than the 7.3% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Skellerup Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

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

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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Skellerup Holdings's Current Liabilities Impact Its 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Skellerup Holdings has total assets of NZ$275m and current liabilities of NZ$30m. As a result, its current liabilities are equal to approximately 11% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Skellerup Holdings's ROCE

With that in mind, Skellerup Holdings's ROCE appears pretty good. There might be better investments than Skellerup Holdings 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).

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.

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. Thank you for reading.