Today we'll evaluate Hindcon Chemicals Limited (NSE:HINDCON) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Hindcon Chemicals:

0.12 = ₹35m ÷ (₹362m - ₹59m) (Based on the trailing twelve months to March 2019.)

So, Hindcon Chemicals has an ROCE of 12%.

Check out our latest analysis for Hindcon Chemicals

Does Hindcon Chemicals Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Hindcon Chemicals's ROCE is meaningfully below the Chemicals industry average of 17%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Hindcon Chemicals stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

The image below shows how Hindcon Chemicals's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can check if Hindcon Chemicals has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Hindcon Chemicals's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.