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Should You Worry About China SXT Pharmaceuticals, Inc.’s (NASDAQ:SXTC) ROCE?

Simply Wall St

Today we are going to look at China SXT Pharmaceuticals, Inc. (NASDAQ:SXTC) 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. And finally, we'll look at how its current liabilities are impacting 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. 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.

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 China SXT Pharmaceuticals:

0.16 = US$1.8m ÷ (US$17m - US$6.3m) (Based on the trailing twelve months to March 2019.)

So, China SXT Pharmaceuticals has an ROCE of 16%.

See our latest analysis for China SXT Pharmaceuticals

Is China SXT Pharmaceuticals's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, China SXT Pharmaceuticals's ROCE appears meaningfully below the 21% average reported by the Personal Products industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how China SXT Pharmaceuticals compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

China SXT Pharmaceuticals's current ROCE of 16% is lower than its ROCE in the past, which was 28%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how China SXT Pharmaceuticals's past growth compares to other companies.

NasdaqCM:SXTC Past Revenue and Net Income, November 14th 2019

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. How cyclical is China SXT Pharmaceuticals? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How China SXT Pharmaceuticals's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

China SXT Pharmaceuticals has total liabilities of US$6.3m and total assets of US$17m. As a result, its current liabilities are equal to approximately 36% of its total assets. With this level of current liabilities, China SXT Pharmaceuticals's ROCE is boosted somewhat.

What We Can Learn From China SXT Pharmaceuticals's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. China SXT Pharmaceuticals 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.

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 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. Thank you for reading.