Today we'll look at Force Motors Limited (NSE:FORCEMOT) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Force Motors:

0.049 = ₹1.1b ÷ (₹28b - ₹6.5b) (Based on the trailing twelve months to June 2019.)

Therefore, Force Motors has an ROCE of 4.9%.

View our latest analysis for Force Motors

Does Force Motors Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In this analysis, Force Motors's ROCE appears meaningfully below the 13% average reported by the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Force Motors stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

Force Motors's current ROCE of 4.9% is lower than its ROCE in the past, which was 13%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Force Motors'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. 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. You can check if Force Motors has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Force Motors'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 counter this, investors can check if a company has high current liabilities relative to total assets.