Today we'll look at Cera Sanitaryware Limited (NSE:CERA) 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.

Firstly, we'll go over how we 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.

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 Cera Sanitaryware:

0.20 = ₹1.7b ÷ (₹12b - ₹3.7b) (Based on the trailing twelve months to June 2019.)

So, Cera Sanitaryware has an ROCE of 20%.

See our latest analysis for Cera Sanitaryware

Is Cera Sanitaryware's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Cera Sanitaryware's ROCE is meaningfully better than the 13% average in the Building 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. Regardless of where Cera Sanitaryware sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can click on the image below to see (in greater detail) how Cera Sanitaryware's past growth compares to other companies.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cera Sanitaryware.

Do Cera Sanitaryware'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.

Cera Sanitaryware has total assets of ₹12b and current liabilities of ₹3.7b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. With this level of current liabilities, Cera Sanitaryware's ROCE is boosted somewhat.

The Bottom Line On Cera Sanitaryware's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Cera Sanitaryware looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.