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Today we'll evaluate Hatsun Agro Product Limited (NSE:HATSUN) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to 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.

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. In general, businesses with a higher ROCE are usually better quality. 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 Hatsun Agro Product:

0.18 = ₹2.4b ÷ (₹22b - ₹9.0b) (Based on the trailing twelve months to March 2019.)

Therefore, Hatsun Agro Product has an ROCE of 18%.

Check out our latest analysis for Hatsun Agro Product

Does Hatsun Agro Product Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Hatsun Agro Product's ROCE is meaningfully better than the 12% 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. Independently of how Hatsun Agro Product compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Hatsun Agro Product's current ROCE of 18% is lower than its ROCE in the past, which was 41%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Hatsun Agro Product's ROCE compares to its industry, and you can click it to see more detail on its past growth.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Hatsun Agro Product's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Hatsun Agro Product has total assets of ₹22b and current liabilities of ₹9.0b. As a result, its current liabilities are equal to approximately 40% of its total assets. Hatsun Agro Product has a medium level of current liabilities, which would boost the ROCE.

The Bottom Line On Hatsun Agro Product's ROCE

Hatsun Agro Product's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than Hatsun Agro Product 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.