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Today we are going to look at Baba Agro Food Limited (NSE:BABAFOOD) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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'.

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 Baba Agro Food:

0.33 = ₹75m ÷ (₹564m - ₹339m) (Based on the trailing twelve months to March 2018.)

So, Baba Agro Food has an ROCE of 33%.

View our latest analysis for Baba Agro Food

Does Baba Agro Food Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Baba Agro Food's ROCE appears to be substantially greater than the 12% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Baba Agro Food's ROCE in absolute terms currently looks quite high.

Our data shows that Baba Agro Food currently has an ROCE of 33%, compared to its ROCE of 14% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Baba Agro Food's ROCE compares to its industry, and you can click it to see more detail on its past growth.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Baba Agro Food has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Baba Agro Food's Current Liabilities And Their Impact On 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. 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.

Baba Agro Food has total liabilities of ₹339m and total assets of ₹564m. As a result, its current liabilities are equal to approximately 60% of its total assets. While a high level of current liabilities boosts its ROCE, Baba Agro Food's returns are still very good.

What We Can Learn From Baba Agro Food's ROCE

So we would be interested in doing more research here -- there may be an opportunity! Baba Agro Food looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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.