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Here’s why IT Tech Packaging, Inc.’s (NYSEMKT:ITP) Returns On Capital Matters So Much

Simply Wall St

Today we'll evaluate IT Tech Packaging, Inc. (NYSEMKT:ITP) 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.

Firstly, 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.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 IT Tech Packaging:

0.022 = US$3.9m ÷ (US$190m - US$17m) (Based on the trailing twelve months to December 2019.)

Therefore, IT Tech Packaging has an ROCE of 2.2%.

Check out our latest analysis for IT Tech Packaging

Is IT Tech Packaging's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see IT Tech Packaging's ROCE is meaningfully below the Forestry industry average of 9.2%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how IT Tech Packaging stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

We can see that, IT Tech Packaging currently has an ROCE of 2.2%, less than the 7.0% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how IT Tech Packaging's ROCE compares to its industry, and you can click it to see more detail on its past growth.

AMEX:ITP Past Revenue and Net Income March 26th 2020

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, after all, simply a snap shot of a single year. How cyclical is IT Tech Packaging? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect IT Tech Packaging's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

IT Tech Packaging has current liabilities of US$17m and total assets of US$190m. Therefore its current liabilities are equivalent to approximately 8.9% of its total assets. IT Tech Packaging has very few current liabilities, which have a minimal effect on its already low ROCE.

Our Take On IT Tech Packaging's ROCE

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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.