Today we are going to look at Washington H. Soul Pattinson and Company Limited (ASX:SOL) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the 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?

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 Washington H. Soul Pattinson:

0.065 = AU$346m ÷ (AU$5.7b - AU$321m) (Based on the trailing twelve months to January 2019.)

So, Washington H. Soul Pattinson has an ROCE of 6.5%.

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Does Washington H. Soul Pattinson Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Washington H. Soul Pattinson's ROCE appears meaningfully below the 10% average reported by the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Washington H. Soul Pattinson's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

In our analysis, Washington H. Soul Pattinson's ROCE appears to be 6.5%, compared to 3 years ago, when its ROCE was 1.6%. This makes us think about whether the company has been reinvesting shrewdly.

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. We note Washington H. Soul Pattinson could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Washington H. Soul Pattinson.

Washington H. Soul Pattinson's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Washington H. Soul Pattinson has total liabilities of AU$321m and total assets of AU$5.7b. Therefore its current liabilities are equivalent to approximately 5.7% of its total assets. Washington H. Soul Pattinson has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

The Bottom Line On Washington H. Soul Pattinson's ROCE

Based on this information, Washington H. Soul Pattinson appears to be a mediocre business. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.