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Today we are going to look at Adani Gas Limited (NSE:ADANIGAS) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?

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 Adani Gas:

0.22 = ₹3.4b ÷ (₹17b - ₹1.4b) (Based on the trailing twelve months to December 2018.)

So, Adani Gas has an ROCE of 22%.

View our latest analysis for Adani Gas

Does Adani Gas Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Adani Gas's ROCE is around the 20% average reported by the Gas Utilities industry. Regardless of where Adani Gas sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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, after all, simply a snap shot of a single year. How cyclical is Adani Gas? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Adani Gas'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.