Today we are going to look at R M Drip and Sprinklers Systems Limited (NSE:RMDRIP) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from 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'.

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 R M Drip and Sprinklers Systems:

0.15 = ₹33m ÷ (₹325m - ₹106m) (Based on the trailing twelve months to March 2018.)

So, R M Drip and Sprinklers Systems has an ROCE of 15%.

View our latest analysis for R M Drip and Sprinklers Systems

Is R M Drip and Sprinklers Systems's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that R M Drip and Sprinklers Systems's ROCE is fairly close to the Machinery industry average of 15%. Aside from the industry comparison, R M Drip and Sprinklers Systems's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

As we can see, R M Drip and Sprinklers Systems currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 7.5%. This makes us wonder if the company is improving.

It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. How cyclical is R M Drip and Sprinklers Systems? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do R M Drip and Sprinklers Systems's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

R M Drip and Sprinklers Systems has total assets of ₹325m and current liabilities of ₹106m. Therefore its current liabilities are equivalent to approximately 33% of its total assets. R M Drip and Sprinklers Systems's middling level of current liabilities have the effect of boosting its ROCE a bit.

Our Take On R M Drip and Sprinklers Systems's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: make sure you look for a great company, not just the first idea you come across. 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.