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Why You Should Care About Kinetix Systems Holdings Limited’s (HKG:8606) Low Return On Capital

Simply Wall St

Today we are going to look at Kinetix Systems Holdings Limited (HKG:8606) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. 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. 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'.

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 Kinetix Systems Holdings:

0.033 = HK$3.1m ÷ (HK$156m - HK$61m) (Based on the trailing twelve months to June 2019.)

Therefore, Kinetix Systems Holdings has an ROCE of 3.3%.

View our latest analysis for Kinetix Systems Holdings

Does Kinetix Systems Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Kinetix Systems Holdings's ROCE is meaningfully below the IT industry average of 12%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Kinetix Systems Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

Kinetix Systems Holdings's current ROCE of 3.3% is lower than 3 years ago, when the company reported a 54% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Kinetix Systems Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:8606 Past Revenue and Net Income, August 16th 2019

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 only a point-in-time measure. You can check if Kinetix Systems Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Kinetix Systems 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Kinetix Systems Holdings has total assets of HK$156m and current liabilities of HK$61m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. Kinetix Systems Holdings has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.

Our Take On Kinetix Systems Holdings's ROCE

So researching other companies may be a better use of your time. Of course, you might also be able to find a better stock than Kinetix Systems Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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 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.