Today we'll look at Drillcon AB (publ) (STO:DRIL) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 Drillcon:

0.20 = kr36m ÷ (kr313m - kr129m) (Based on the trailing twelve months to June 2019.)

Therefore, Drillcon has an ROCE of 20%.

View our latest analysis for Drillcon

Is Drillcon's ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Drillcon's ROCE is meaningfully higher than the 15% average in the Metals and Mining 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. Setting aside the comparison to its industry for a moment, Drillcon's ROCE in absolute terms currently looks quite high.

Our data shows that Drillcon currently has an ROCE of 20%, compared to its ROCE of 8.4% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Drillcon's ROCE compares to its industry. Click to see more on 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Drillcon could be considered cyclical. How cyclical is Drillcon? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Drillcon's 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Drillcon has total liabilities of kr129m and total assets of kr313m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. Drillcon has a medium level of current liabilities, boosting its ROCE somewhat.

Our Take On Drillcon's ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. Drillcon shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.