Today we are going to look at The United Nilgiri Tea Estates Company Limited (NSE:UNITEDTEA) 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. 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 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'.

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 United Nilgiri Tea Estates:

0.083 = ₹118m ÷ (₹1.5b - ₹54m) (Based on the trailing twelve months to March 2019.)

So, United Nilgiri Tea Estates has an ROCE of 8.3%.

See our latest analysis for United Nilgiri Tea Estates

Is United Nilgiri Tea Estates's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see United Nilgiri Tea Estates's ROCE is meaningfully below the Food industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside United Nilgiri Tea Estates's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

United Nilgiri Tea Estates's current ROCE of 8.3% is lower than its ROCE in the past, which was 17%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how United Nilgiri Tea Estates's ROCE compares to its industry. Click to see more on past growth.

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 only a point-in-time measure. How cyclical is United Nilgiri Tea Estates? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect United Nilgiri Tea Estates's 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

United Nilgiri Tea Estates has total liabilities of ₹54m and total assets of ₹1.5b. Therefore its current liabilities are equivalent to approximately 3.7% of its total assets. With barely any current liabilities, there is minimal impact on United Nilgiri Tea Estates's admittedly low ROCE.

Our Take On United Nilgiri Tea Estates's ROCE

Still, investors could probably find more attractive prospects with better performance out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.