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Today we’ll look at Essel Propack Limited (NSE:ESSELPRO) 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.

First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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 Essel Propack:

0.17 = ₹3.1b ÷ (₹27b – ₹7.8b) (Based on the trailing twelve months to December 2018.)

So, Essel Propack has an ROCE of 17%.

Check out our latest analysis for Essel Propack

Is Essel Propack’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Essel Propack’s ROCE appears to be around the 16% average of the Packaging industry. Separate from Essel Propack’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Essel Propack.

What Are Current Liabilities, And How Do They Affect Essel Propack’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.