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Today we'll evaluate Pearl Global Industries Limited (NSE:PGIL) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding 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'.

How Do You Calculate Return On Capital Employed?

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 Pearl Global Industries:

0.092 = ₹508m ÷ (₹11b - ₹5.1b) (Based on the trailing twelve months to December 2018.)

So, Pearl Global Industries has an ROCE of 9.2%.

See our latest analysis for Pearl Global Industries

Is Pearl Global Industries's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Pearl Global Industries's ROCE is fairly close to the Luxury industry average of 11%. Independently of how Pearl Global Industries compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. Readers may wish to look for more rewarding investments.

As we can see, Pearl Global Industries currently has an ROCE of 9.2%, less than the 13% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Pearl Global Industries? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Pearl Global Industries's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Pearl Global Industries has total liabilities of ₹5.1b and total assets of ₹11b. Therefore its current liabilities are equivalent to approximately 48% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Pearl Global Industries's ROCE is concerning.

The Bottom Line On Pearl Global Industries's ROCE

So researching other companies may be a better use of your time. But note: Pearl Global Industries 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 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.