Today we'll look at Netel Technology (Holdings) Limited (HKG:8256) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 Netel Technology (Holdings):
0.53 = HK$6.1m ÷ (HK$21m - HK$9.6m) (Based on the trailing twelve months to February 2019.)
So, Netel Technology (Holdings) has an ROCE of 53%.
Is Netel Technology (Holdings)'s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Netel Technology (Holdings)'s ROCE appears to be substantially greater than the 9.3% average in the Telecom industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Netel Technology (Holdings)'s ROCE is currently very good.
Netel Technology (Holdings) delivered an ROCE of 53%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can see in the image below how Netel Technology (Holdings)'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. 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 Netel Technology (Holdings) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Netel Technology (Holdings)'s Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Netel Technology (Holdings) has total assets of HK$21m and current liabilities of HK$9.6m. As a result, its current liabilities are equal to approximately 46% of its total assets. Netel Technology (Holdings) has a medium level of current liabilities, boosting its ROCE somewhat.
The Bottom Line On Netel Technology (Holdings)'s ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. Netel Technology (Holdings) 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 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.