Today we’ll look at Simplex Infrastructures Limited (NSE:SIMPLEXINF) and reflect on its potential as an investment. 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. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Simplex Infrastructures:

0.24 = ₹5.5b ÷ (₹92b – ₹69b) (Based on the trailing twelve months to March 2018.)

Therefore, Simplex Infrastructures has an ROCE of 24%.

View our latest analysis for Simplex Infrastructures

Does Simplex Infrastructures Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Simplex Infrastructures’s ROCE is meaningfully better than the 13% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Simplex Infrastructures sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Simplex Infrastructures’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.

Simplex Infrastructures has total liabilities of ₹69b and total assets of ₹92b. Therefore its current liabilities are equivalent to approximately 75% of its total assets. Simplex Infrastructures has a relatively high level of current liabilities, boosting its ROCE meaningfully.

What We Can Learn From Simplex Infrastructures’s ROCE

While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. You might be able to find a better buy than Simplex Infrastructures. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.