Today we are going to look at China National Building Material Company Limited (HKG:3323) 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.

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 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. 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'.

How Do You Calculate Return On Capital Employed?

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 China National Building Material:

0.14 = CN¥35b ÷ (CN¥447b - CN¥198b) (Based on the trailing twelve months to December 2019.)

Therefore, China National Building Material has an ROCE of 14%.

Check out our latest analysis for China National Building Material

Is China National Building Material's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, China National Building Material's ROCE appears to be around the 18% average of the Basic Materials industry. Independently of how China National Building Material compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

We can see that, China National Building Material currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 6.5%. This makes us wonder if the company is improving. You can see in the image below how China National Building Material's ROCE compares to its industry. Click to see more on past growth.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do China National Building Material's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

China National Building Material has total assets of CN¥447b and current liabilities of CN¥198b. As a result, its current liabilities are equal to approximately 44% of its total assets. With this level of current liabilities, China National Building Material's ROCE is boosted somewhat.

What We Can Learn From China National Building Material's ROCE

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

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.