Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we are going to look at Nanjing Sample Technology Company Limited (HKG:1708) to see whether it might be an attractive investment prospect. 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 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.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Nanjing Sample Technology:
0.11 = CN¥283m ÷ (CN¥4.8b - CN¥2.2b) (Based on the trailing twelve months to December 2018.)
So, Nanjing Sample Technology has an ROCE of 11%.
Does Nanjing Sample Technology Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Nanjing Sample Technology's ROCE appears to be around the 9.9% average of the Electronic industry. Separate from Nanjing Sample Technology's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Nanjing Sample Technology's ROCE appears to be 11%, compared to 3 years ago, when its ROCE was 8.6%. This makes us think the business might be improving. You can see in the image below how Nanjing Sample Technology's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. You can check if Nanjing Sample Technology has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Nanjing Sample Technology's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Nanjing Sample Technology has total liabilities of CN¥2.2b and total assets of CN¥4.8b. As a result, its current liabilities are equal to approximately 46% of its total assets. Nanjing Sample Technology has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On Nanjing Sample Technology's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Nanjing Sample Technology looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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 email@example.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.