Today we'll look at Sundram Fasteners Limited (NSE:SUNDRMFAST) 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.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. All else being equal, a better business will have a higher ROCE. 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 Sundram Fasteners:

0.27 = ₹6.6b ÷ (₹37b - ₹13b) (Based on the trailing twelve months to June 2019.)

So, Sundram Fasteners has an ROCE of 27%.

See our latest analysis for Sundram Fasteners

Does Sundram Fasteners Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Sundram Fasteners's ROCE is meaningfully higher than the 15% average in the Auto Components industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Sundram Fasteners's ROCE is currently very good.

You can click on the image below to see (in greater detail) how Sundram Fasteners's past growth compares to other companies.

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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sundram Fasteners.

Sundram Fasteners'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.

Sundram Fasteners has total assets of ₹37b and current liabilities of ₹13b. As a result, its current liabilities are equal to approximately 35% of its total assets. Sundram Fasteners's ROCE is boosted somewhat by its middling amount of current liabilities.

The Bottom Line On Sundram Fasteners's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than Sundram Fasteners out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.