Today we are going to look at Pact Group Holdings Ltd (ASX:PGH) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Pact Group Holdings:

0.091 = AU$135m ÷ (AU$2.0b - AU$512m) (Based on the trailing twelve months to December 2019.)

Therefore, Pact Group Holdings has an ROCE of 9.1%.

See our latest analysis for Pact Group Holdings

Does Pact Group Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Pact Group Holdings's ROCE appears to be around the 11% average of the Packaging industry. Separate from Pact Group Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Pact Group Holdings's current ROCE of 9.1% is lower than its ROCE in the past, which was 13%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Pact Group Holdings's past growth compares to other companies.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Pact Group Holdings.

What Are Current Liabilities, And How Do They Affect Pact Group Holdings's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.