Today we are going to look at Sinosoft Technology Group Limited (HKG:1297) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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 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. 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?
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 Sinosoft Technology Group:
0.22 = CN¥308m ÷ (CN¥1.7b - CN¥261m) (Based on the trailing twelve months to December 2018.)
Therefore, Sinosoft Technology Group has an ROCE of 22%.
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Does Sinosoft Technology Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Sinosoft Technology Group's ROCE appears to be substantially greater than the 9.1% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Sinosoft Technology Group's ROCE is currently very good.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sinosoft Technology Group.
How Sinosoft Technology Group's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Sinosoft Technology Group has total assets of CN¥1.7b and current liabilities of CN¥261m. As a result, its current liabilities are equal to approximately 16% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Sinosoft Technology Group's ROCE
Low current liabilities and high ROCE is a good combination, making Sinosoft Technology Group look quite interesting. Sinosoft Technology Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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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 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.