Today we are going to look at Elders Limited (ASX:ELD) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. 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'.

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 Elders:

0.13 = AU$67m ÷ (AU$1.0b - AU$504m) (Based on the trailing twelve months to September 2019.)

Therefore, Elders has an ROCE of 13%.

See our latest analysis for Elders

Is Elders's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Elders's ROCE is meaningfully higher than the 6.1% average in the Food 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 Elders's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Elders's current ROCE of 13% is lower than 3 years ago, when the company reported a 28% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Elders's ROCE compares to its industry. Click to see more on past growth.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Elders.

How Elders's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.