Today we'll evaluate Dynamic Colours Limited (SGX:D6U) 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.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is 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. In general, businesses with a higher ROCE are usually better quality. 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 Dynamic Colours:

0.052 = US$1.8m ÷ (US$38m - US$3.7m) (Based on the trailing twelve months to June 2019.)

Therefore, Dynamic Colours has an ROCE of 5.2%.

Check out our latest analysis for Dynamic Colours

Is Dynamic Colours's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Dynamic Colours's ROCE appears to be around the 6.5% average of the Chemicals industry. Aside from the industry comparison, Dynamic Colours's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Dynamic Colours's current ROCE of 5.2% is lower than its ROCE in the past, which was 10%, 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 Dynamic Colours's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. How cyclical is Dynamic Colours? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.