Today we’ll look at Vardhman Acrylics Limited (NSE:VARDHACRLC) 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. 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 Vardhman Acrylics:

0.054 = ₹188m ÷ (₹4.8b – ₹1.3b) (Based on the trailing twelve months to December 2018.)

Therefore, Vardhman Acrylics has an ROCE of 5.4%.

See our latest analysis for Vardhman Acrylics

Does Vardhman Acrylics Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Vardhman Acrylics’s ROCE is meaningfully below the Luxury industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Vardhman Acrylics’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.

As we can see, Vardhman Acrylics currently has an ROCE of 5.4%, less than the 8.0% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. If Vardhman Acrylics is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Vardhman Acrylics’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Vardhman Acrylics has total liabilities of ₹1.3b and total assets of ₹4.8b. As a result, its current liabilities are equal to approximately 27% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

The Bottom Line On Vardhman Acrylics’s ROCE

Vardhman Acrylics has a poor ROCE, and there may be better investment prospects out there. But note: Vardhman Acrylics may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.