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Here’s why Courage Investment Group Limited’s (HKG:1145) Returns On Capital Matters So Much

Simply Wall St

Today we'll look at Courage Investment Group Limited (HKG:1145) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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?

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 Courage Investment Group:

0.02 = US$1.2m ÷ (US$64m - US$5.8m) (Based on the trailing twelve months to June 2019.)

So, Courage Investment Group has an ROCE of 2.0%.

View our latest analysis for Courage Investment Group

Does Courage Investment Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, Courage Investment Group's ROCE appears to be significantly below the 3.0% average in the Shipping industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Courage Investment Group's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

Courage Investment Group reported an ROCE of 2.0% -- 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 Courage Investment Group's ROCE compares to its industry. Click to see more on past growth.

SEHK:1145 Past Revenue and Net Income, October 18th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Courage Investment Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Courage Investment Group's Current Liabilities Impact 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.

Courage Investment Group has total liabilities of US$5.8m and total assets of US$64m. As a result, its current liabilities are equal to approximately 9.0% of its total assets. Courage Investment Group has a low level of current liabilities, which have a negligible impact on its already low ROCE.

The Bottom Line On Courage Investment Group's ROCE

Nonetheless, there may be better places to invest your capital. 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).

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.