Today we are going to look at Contel Technology Company Limited (HKG:1912) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Contel Technology:

0.41 = US$5.9m ÷ (US$42m - US$28m) (Based on the trailing twelve months to June 2019.)

Therefore, Contel Technology has an ROCE of 41%.

View our latest analysis for Contel Technology

Is Contel Technology's ROCE Good?

One way to assess ROCE is to compare similar companies. Contel Technology's ROCE appears to be substantially greater than the 10% average in the Electronic 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. Setting aside the comparison to its industry for a moment, Contel Technology's ROCE in absolute terms currently looks quite high.

Our data shows that Contel Technology currently has an ROCE of 41%, compared to its ROCE of 29% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Contel Technology'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. If Contel Technology is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Contel Technology'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Contel Technology has current liabilities of US$28m and total assets of US$42m. Therefore its current liabilities are equivalent to approximately 66% of its total assets. Contel Technology's high level of current liabilities boost the ROCE - but its ROCE is still impressive.

The Bottom Line On Contel Technology's ROCE

In my book, this business could be worthy of further research. There might be better investments than Contel Technology out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

I will like Contel Technology better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.