Today we'll look at Washington H. Soul Pattinson and Company Limited (ASX:SOL) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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'.

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 Washington H. Soul Pattinson:

0.066 = AU$366m ÷ (AU$5.9b - AU$305m) (Based on the trailing twelve months to July 2019.)

Therefore, Washington H. Soul Pattinson has an ROCE of 6.6%.

Check out our latest analysis for Washington H. Soul Pattinson

Is Washington H. Soul Pattinson's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Washington H. Soul Pattinson's ROCE appears to be significantly below the 13% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Washington H. Soul Pattinson's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Our data shows that Washington H. Soul Pattinson currently has an ROCE of 6.6%, compared to its ROCE of 2.4% 3 years ago. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Washington H. Soul Pattinson's past growth compares to other companies.

When considering this metric, keep in mind that it is backwards looking, and 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. Given the industry it operates in, Washington H. Soul Pattinson could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Washington H. Soul Pattinson.

Washington H. Soul Pattinson's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Washington H. Soul Pattinson has total assets of AU$5.9b and current liabilities of AU$305m. Therefore its current liabilities are equivalent to approximately 5.2% of its total assets. Washington H. Soul Pattinson reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On Washington H. Soul Pattinson's ROCE

If performance improves, then Washington H. Soul Pattinson may be an OK investment, especially at the right valuation. But note: make sure you look for a great company, not just the first idea you come across. 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.