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Today we'll look at Surana Solar Limited (NSE:SURANASOL) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Surana Solar:

0.036 = ₹24m ÷ (₹812m - ₹137m) (Based on the trailing twelve months to December 2018.)

Therefore, Surana Solar has an ROCE of 3.6%.

Check out our latest analysis for Surana Solar

Does Surana Solar Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Surana Solar's ROCE appears meaningfully below the 6.8% average reported by the Semiconductor industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Surana Solar compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. There are potentially more appealing investments elsewhere.

Surana Solar's current ROCE of 3.6% is lower than its ROCE in the past, which was 18%, 3 years ago. Therefore we wonder if the company is facing new headwinds.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. You can check if Surana Solar has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.