Today we'll look at Wuxi Sunlit Science and Technology Company Limited (HKG:1289) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Wuxi Sunlit Science and Technology:
0.0015 = CN¥949k ÷ (CN¥767m - CN¥138m) (Based on the trailing twelve months to June 2019.)
Therefore, Wuxi Sunlit Science and Technology has an ROCE of 0.2%.
Does Wuxi Sunlit Science and Technology Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Wuxi Sunlit Science and Technology's ROCE is meaningfully below the Machinery industry average of 11%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Wuxi Sunlit Science and Technology stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Wuxi Sunlit Science and Technology reported an ROCE of 0.2% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can click on the image below to see (in greater detail) how Wuxi Sunlit Science and Technology's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 Wuxi Sunlit Science and Technology is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Wuxi Sunlit Science and Technology'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Wuxi Sunlit Science and Technology has total liabilities of CN¥138m and total assets of CN¥767m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Wuxi Sunlit Science and Technology's ROCE
While that is good to see, Wuxi Sunlit Science and Technology has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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