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Why Chanjet Information Technology Company Limited’s (HKG:1588) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll evaluate Chanjet Information Technology Company Limited (HKG:1588) to determine whether it could have potential as an investment idea. 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.

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.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the 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'.

So, How Do We Calculate ROCE?

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 Chanjet Information Technology:

0.00005 = CN¥70k ÷ (CN¥1.6b - CN¥305m) (Based on the trailing twelve months to June 2019.)

So, Chanjet Information Technology has an ROCE of 0.005%.

See our latest analysis for Chanjet Information Technology

Is Chanjet Information Technology's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Chanjet Information Technology's ROCE is meaningfully below the Software industry average of 6.7%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Chanjet Information Technology stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

Chanjet Information Technology reported an ROCE of 0.005% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how Chanjet Information Technology's ROCE compares to its industry. Click to see more on past growth.

SEHK:1588 Past Revenue and Net Income, December 8th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Chanjet Information Technology'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Chanjet Information Technology has total assets of CN¥1.6b and current liabilities of CN¥305m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On Chanjet Information Technology's ROCE

That's not a bad thing, however Chanjet Information Technology has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Chanjet Information Technology. 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.

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.