Today we'll evaluate Filatex India Limited (NSE:FILATEX) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of 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.

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. Overall, it is a valuable metric that has its flaws. 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?

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 Filatex India:

0.16 = ₹1.7b ÷ (₹14b - ₹3.7b) (Based on the trailing twelve months to March 2019.)

Therefore, Filatex India has an ROCE of 16%.

View our latest analysis for Filatex India

Does Filatex India Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Filatex India's ROCE is meaningfully higher than the 12% average in the Luxury industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Filatex India's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Our data shows that Filatex India currently has an ROCE of 16%, compared to its ROCE of 13% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Filatex India's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Filatex India has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Filatex India's Current Liabilities And Their Impact On Its 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.

Filatex India has total assets of ₹14b and current liabilities of ₹3.7b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Filatex India's ROCE

With that in mind, Filatex India's ROCE appears pretty good. There might be better investments than Filatex India out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

Filatex India is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider 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.