Today we'll evaluate Kelso Technologies Inc. (TSE:KLS) to determine whether it could have potential as an investment idea. 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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Kelso Technologies:

0.32 = US$3.3m ÷ (US$12m - US$2.1m) (Based on the trailing twelve months to September 2019.)

Therefore, Kelso Technologies has an ROCE of 32%.

Check out our latest analysis for Kelso Technologies

Does Kelso Technologies Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Kelso Technologies's ROCE is meaningfully better than the 9.7% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Kelso Technologies's ROCE currently appears to be excellent.

Kelso Technologies reported an ROCE of 32% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Kelso Technologies's past growth compares to other companies.

It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Kelso Technologies is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.