Today we'll look at Neenah, Inc. (NYSE:NP) 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.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

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 Neenah:

0.11 = US$83m ÷ (US$828m - US$100m) (Based on the trailing twelve months to December 2019.)

Therefore, Neenah has an ROCE of 11%.

View our latest analysis for Neenah

Is Neenah's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Neenah's ROCE appears to be substantially greater than the 9.2% average in the Forestry industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Neenah's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Neenah's current ROCE of 11% is lower than its ROCE in the past, which was 18%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Neenah's ROCE compares to its industry. Click to see more on past growth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Neenah.

Neenah's Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.