Today we'll look at Objective Corporation Limited (ASX:OCL) 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.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?

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 Objective:

0.28 = AU$11m ÷ (AU$77m - AU$36m) (Based on the trailing twelve months to June 2019.)

So, Objective has an ROCE of 28%.

Check out our latest analysis for Objective

Does Objective Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Objective's ROCE appears to be substantially greater than the 20% average in the Software 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. Putting aside its position relative to its industry for now, in absolute terms, Objective's ROCE is currently very good.

You can click on the image below to see (in greater detail) how Objective's past growth compares to other companies.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Objective.

How Objective's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.

Objective has current liabilities of AU$36m and total assets of AU$77m. As a result, its current liabilities are equal to approximately 47% of its total assets. Objective has a medium level of current liabilities, boosting its ROCE somewhat.

The Bottom Line On Objective's ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. Objective shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Objective better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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