Today we’ll evaluate Nanjing Sample Technology Company Limited (HKG:1708) to determine whether it could have potential as an investment idea. 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Nanjing Sample Technology:
0.12 = CN¥244m ÷ (CN¥4.5b – CN¥2.1b) (Based on the trailing twelve months to June 2018.)
Therefore, Nanjing Sample Technology has an ROCE of 12%.
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Does Nanjing Sample Technology Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Nanjing Sample Technology’s ROCE is around the 11% average reported by the Electronic industry. Regardless of where Nanjing Sample Technology sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. If Nanjing Sample Technology is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Nanjing Sample Technology’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Nanjing Sample Technology has total assets of CN¥4.5b and current liabilities of CN¥2.1b. As a result, its current liabilities are equal to approximately 47% of its total assets. With this level of current liabilities, Nanjing Sample Technology’s ROCE is boosted somewhat.
What We Can Learn From Nanjing Sample Technology’s ROCE
Nanjing Sample Technology’s ROCE does look good, but the level of current liabilities also contribute to that. Of course you might be able to find a better stock than Nanjing Sample 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.