Today we’ll look at AGC Networks Limited (NSE:AGCNET) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.’

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 AGC Networks:

0.30 = ₹251m ÷ (₹6.1b – ₹4.6b) (Based on the trailing twelve months to September 2018.)

So, AGC Networks has an ROCE of 30%.

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Is AGC Networks’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. AGC Networks’s ROCE appears to be substantially greater than the 14% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, AGC Networks’s ROCE in absolute terms currently looks quite high.

Our data shows that AGC Networks currently has an ROCE of 30%, compared to its ROCE of 16% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

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. ROCE is only a point-in-time measure. If AGC Networks is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

AGC Networks’s Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

AGC Networks has total assets of ₹6.1b and current liabilities of ₹4.6b. Therefore its current liabilities are equivalent to approximately 76% of its total assets. AGC Networks boasts an attractive ROCE, even after considering the boost from high current liabilities.

The Bottom Line On AGC Networks’s ROCE

So to us, the company is potentially worth investigating further. Of course you might be able to find a better stock than AGC Networks. So you may wish to see this free collection of other companies that have grown earnings strongly.

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.