Today we are going to look at Zengame Technology Holding Limited (HKG:2660) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. Overall, it is a valuable metric that has its flaws. 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 Zengame Technology Holding:
0.24 = CN¥130m ÷ (CN¥613m - CN¥62m) (Based on the trailing twelve months to June 2019.)
So, Zengame Technology Holding has an ROCE of 24%.
Is Zengame Technology Holding's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Zengame Technology Holding's ROCE is meaningfully better than the 14% average in the Entertainment 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. Regardless of the industry comparison, in absolute terms, Zengame Technology Holding's ROCE currently appears to be excellent.
The image below shows how Zengame Technology Holding's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Zengame Technology Holding has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Zengame Technology Holding'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Zengame Technology Holding has total liabilities of CN¥62m and total assets of CN¥613m. As a result, its current liabilities are equal to approximately 10% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
The Bottom Line On Zengame Technology Holding's ROCE
Low current liabilities and high ROCE is a good combination, making Zengame Technology Holding look quite interesting. Zengame Technology Holding looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
There are plenty of other companies that have insiders buying up shares. You probably do 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 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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