Today we are going to look at Worth Peripherals Limited (NSE:WORTH) 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.

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 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. 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’.

How Do You Calculate Return On Capital Employed?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Worth Peripherals:

0.22 = ₹180m ÷ (₹998m – ₹180m) (Based on the trailing twelve months to March 2018.)

So, Worth Peripherals has an ROCE of 22%.

Check out our latest analysis for Worth Peripherals

Does Worth Peripherals Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Worth Peripherals’s ROCE is meaningfully better than the 16% average in the Packaging 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. Separate from Worth Peripherals’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Worth Peripherals has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Worth Peripherals’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Worth Peripherals has total assets of ₹998m and current liabilities of ₹180m. As a result, its current liabilities are equal to approximately 18% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On Worth Peripherals’s ROCE

Overall, Worth Peripherals has a decent ROCE and could be worthy of further research. But note: Worth Peripherals may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.