Today we'll evaluate Setubandhan Infrastructure Limited (NSE:SETUINFRA) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. 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. Generally speaking a higher ROCE is better. 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 Setubandhan Infrastructure:

0.04 = ₹60m ÷ (₹2.6b - ₹1.1b) (Based on the trailing twelve months to March 2019.)

Therefore, Setubandhan Infrastructure has an ROCE of 4.0%.

View our latest analysis for Setubandhan Infrastructure

Does Setubandhan Infrastructure Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Setubandhan Infrastructure's ROCE is meaningfully below the Construction industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Setubandhan Infrastructure compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. It is likely that there are more attractive prospects out there.

Setubandhan Infrastructure's current ROCE of 4.0% is lower than its ROCE in the past, which was 9.4%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Setubandhan Infrastructure's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. If Setubandhan Infrastructure is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Setubandhan Infrastructure'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 counter this, investors can check if a company has high current liabilities relative to total assets.

Setubandhan Infrastructure has total assets of ₹2.6b and current liabilities of ₹1.1b. Therefore its current liabilities are equivalent to approximately 41% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Setubandhan Infrastructure's low ROCE is unappealing.

What We Can Learn From Setubandhan Infrastructure's ROCE

So researching other companies may be a better use of your time. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Setubandhan Infrastructure better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.