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Why Tsaker Chemical Group Limited’s (HKG:1986) Return On Capital Employed Is Impressive

Simply Wall St

Today we are going to look at Tsaker Chemical Group Limited (HKG:1986) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding 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. All else being equal, a better business will have a higher ROCE. 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'.

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 Tsaker Chemical Group:

0.43 = CN¥740m ÷ (CN¥2.5b - CN¥808m) (Based on the trailing twelve months to June 2019.)

So, Tsaker Chemical Group has an ROCE of 43%.

See our latest analysis for Tsaker Chemical Group

Is Tsaker Chemical Group's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that Tsaker Chemical Group's ROCE is meaningfully better than the 11% average in the Chemicals industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Tsaker Chemical Group's ROCE is currently very good.

Our data shows that Tsaker Chemical Group currently has an ROCE of 43%, compared to its ROCE of 13% 3 years ago. This makes us think the business might be improving. You can see in the image below how Tsaker Chemical Group's ROCE compares to its industry. Click to see more on past growth.

SEHK:1986 Past Revenue and Net Income, March 2nd 2020

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, after all, simply a snap shot of a single year. You can check if Tsaker Chemical Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Tsaker Chemical Group's ROCE?

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

Tsaker Chemical Group has total assets of CN¥2.5b and current liabilities of CN¥808m. Therefore its current liabilities are equivalent to approximately 32% of its total assets. Tsaker Chemical Group has a medium level of current liabilities, boosting its ROCE somewhat.

The Bottom Line On Tsaker Chemical Group's ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. Tsaker Chemical 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.