Today we are going to look at China Futex Holdings Limited (HKG:8506) to see whether it might be an attractive investment prospect. 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. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Futex Holdings:

0.22 = CN¥29m ÷ (CN¥196m - CN¥64m) (Based on the trailing twelve months to June 2019.)

Therefore, China Futex Holdings has an ROCE of 22%.

See our latest analysis for China Futex Holdings

Is China Futex Holdings's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that China Futex Holdings's ROCE is meaningfully better than the 9.9% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, China Futex Holdings's ROCE currently appears to be excellent.

China Futex Holdings's current ROCE of 22% is lower than 3 years ago, when the company reported a 61% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how China Futex Holdings's past growth compares to other companies.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. How cyclical is China Futex Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do China Futex Holdings's Current Liabilities Skew 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.