Today we are going to look at Silver Touch Technologies Limited (NSE:SILVERTUC) to see whether it might be an attractive investment prospect. 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.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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 Silver Touch Technologies:

0.21 = ₹165m ÷ (₹1.3b - ₹537m) (Based on the trailing twelve months to March 2019.)

So, Silver Touch Technologies has an ROCE of 21%.

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Does Silver Touch Technologies Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Silver Touch Technologies's ROCE appears to be substantially greater than the 14% average in the IT industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Silver Touch Technologies compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

In our analysis, Silver Touch Technologies's ROCE appears to be 21%, compared to 3 years ago, when its ROCE was 16%. This makes us wonder if the company is improving.

It is important to remember that ROCE shows past performance, and is 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, after all, simply a snap shot of a single year. If Silver Touch Technologies is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Silver Touch Technologies's Current Liabilities Skew 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. 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.

Silver Touch Technologies has total assets of ₹1.3b and current liabilities of ₹537m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. With this level of current liabilities, Silver Touch Technologies's ROCE is boosted somewhat.

The Bottom Line On Silver Touch Technologies's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Silver Touch Technologies looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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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.