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Should You Like Gemilang International Limited’s (HKG:6163) High Return On Capital Employed?

Today we are going to look at Gemilang International Limited (HKG:6163) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to 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.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Gemilang International:

0.24 = US\$4.2m ÷ (US\$43m - US\$25m) (Based on the trailing twelve months to April 2019.)

So, Gemilang International has an ROCE of 24%.

Is Gemilang International's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Gemilang International's ROCE is meaningfully higher than the 11% average in the Machinery industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Gemilang International's ROCE currently appears to be excellent.

Gemilang International's current ROCE of 24% is lower than 3 years ago, when the company reported a 41% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Gemilang International's past growth compares to other companies.

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 only a point-in-time measure. If Gemilang International is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Gemilang International's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Gemilang International has total liabilities of US\$25m and total assets of US\$43m. As a result, its current liabilities are equal to approximately 59% of its total assets. While a high level of current liabilities boosts its ROCE, Gemilang International's returns are still very good.

The Bottom Line On Gemilang International's ROCE

So we would be interested in doing more research here -- there may be an opportunity! Gemilang International shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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.