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Should Skyworth Group Limited’s (HKG:751) Weak Investment Returns Worry You?

Simply Wall St

Today we are going to look at Skyworth Group Limited (HKG:751) 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.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. 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'.

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 Skyworth Group:

0.029 = CN¥603m ÷ (CN¥45b - CN¥24b) (Based on the trailing twelve months to December 2018.)

So, Skyworth Group has an ROCE of 2.9%.

View our latest analysis for Skyworth Group

Is Skyworth Group's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Skyworth Group's ROCE appears to be significantly below the 10% average in the Consumer Durables industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Skyworth Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. There are potentially more appealing investments elsewhere.

Skyworth Group's current ROCE of 2.9% is lower than 3 years ago, when the company reported a 8.8% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Skyworth Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:751 Past Revenue and Net Income, January 15th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 Skyworth Group.

What Are Current Liabilities, And How Do They Affect Skyworth Group's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Skyworth Group has total liabilities of CN¥24b and total assets of CN¥45b. Therefore its current liabilities are equivalent to approximately 53% of its total assets. Current liabilities of this level result in a meaningful boost to Skyworth Group's ROCE.

Our Take On Skyworth Group's ROCE

Unfortunately, its ROCE is also pretty low, so we are cautious about the stock. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.