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Today we are going to look at Hindustan Aeronautics Limited (NSE:HAL) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

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. 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.'

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 Hindustan Aeronautics:

0.11 = ₹25b ÷ (₹505b - ₹284b) (Based on the trailing twelve months to March 2019.)

So, Hindustan Aeronautics has an ROCE of 11%.

View our latest analysis for Hindustan Aeronautics

Is Hindustan Aeronautics's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Hindustan Aeronautics's ROCE is around the 13% average reported by the Aerospace & Defense industry. Setting aside the industry comparison for now, Hindustan Aeronautics's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

We can see that , Hindustan Aeronautics currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 5.9%. This makes us wonder if the company is improving. The image below shows how Hindustan Aeronautics'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. How cyclical is Hindustan Aeronautics? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Hindustan Aeronautics's Current Liabilities Impact 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.

Hindustan Aeronautics has total liabilities of ₹284b and total assets of ₹505b. As a result, its current liabilities are equal to approximately 56% of its total assets. Hindustan Aeronautics has a fairly high level of current liabilities, meaningfully impacting its ROCE.

The Bottom Line On Hindustan Aeronautics's ROCE

Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. Of course, you might also be able to find a better stock than Hindustan Aeronautics. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.