Today we'll look at LKS Holding Group Limited (HKG:1867) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we 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.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 LKS Holding Group:

0.19 = HK$24m ÷ (HK$159m - HK$33m) (Based on the trailing twelve months to September 2019.)

So, LKS Holding Group has an ROCE of 19%.

Check out our latest analysis for LKS Holding Group

Does LKS Holding Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. LKS Holding Group's ROCE appears to be substantially greater than the 10.0% average in the Commercial Services 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. Independently of how LKS Holding Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

We can see that, LKS Holding Group currently has an ROCE of 19%, less than the 43% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how LKS Holding Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is LKS Holding Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do LKS Holding Group'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

LKS Holding Group has total liabilities of HK$33m and total assets of HK$159m. As a result, its current liabilities are equal to approximately 21% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On LKS Holding Group's ROCE

This is good to see, and with a sound ROCE, LKS Holding Group could be worth a closer look. LKS Holding Group 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.