Today we are going to look at China Water Industry Group Limited (HKG:1129) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

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.

What is 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. 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?

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 Water Industry Group:

0.085 = HK$241m ÷ (HK$4.8b - HK$1.9b) (Based on the trailing twelve months to December 2019.)

Therefore, China Water Industry Group has an ROCE of 8.5%.

Check out our latest analysis for China Water Industry Group

Does China Water Industry Group Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see China Water Industry Group's ROCE is around the 8.0% average reported by the Water Utilities industry. Setting aside the industry comparison for now, China Water Industry Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

In our analysis, China Water Industry Group's ROCE appears to be 8.5%, compared to 3 years ago, when its ROCE was 4.2%. This makes us wonder if the company is improving. The image below shows how China Water Industry Group'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is China Water Industry Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How China Water Industry Group's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

China Water Industry Group has current liabilities of HK$1.9b and total assets of HK$4.8b. Therefore its current liabilities are equivalent to approximately 41% of its total assets. China Water Industry Group's ROCE is improved somewhat by its moderate amount of current liabilities.

Our Take On China Water Industry Group's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better investment than China Water Industry Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.