Today we are going to look at Impro Precision Industries Limited (HKG:1286) 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. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. 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?
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 Impro Precision Industries:
0.16 = HK$760m ÷ (HK$6.8b - HK$2.1b) (Based on the trailing twelve months to June 2019.)
So, Impro Precision Industries has an ROCE of 16%.
Is Impro Precision Industries's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Impro Precision Industries's ROCE is meaningfully better than the 9.9% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Impro Precision Industries compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Impro Precision Industries's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Impro Precision Industries.
Do Impro Precision Industries'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Impro Precision Industries has total assets of HK$6.8b and current liabilities of HK$2.1b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Impro Precision Industries has a medium level of current liabilities, which would boost the ROCE.
Our Take On Impro Precision Industries's ROCE
Impro Precision Industries's ROCE does look good, but the level of current liabilities also contribute to that. Impro Precision Industries looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Impro Precision Industries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.