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Today we'll look at KPa-BM Holdings Limited (HKG:2663) 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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 KPa-BM Holdings:

0.19 = HK$33m ÷ (HK$277m - HK$101m) (Based on the trailing twelve months to September 2018.)

Therefore, KPa-BM Holdings has an ROCE of 19%.

See our latest analysis for KPa-BM Holdings

Does KPa-BM Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, KPa-BM Holdings's ROCE is meaningfully higher than the 13% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from KPa-BM Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

As we can see, KPa-BM Holdings currently has an ROCE of 19%, less than the 52% it reported 3 years ago. This makes us wonder if the business is facing new challenges.

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. You can check if KPa-BM Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

KPa-BM Holdings's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

KPa-BM Holdings has total assets of HK$277m and current liabilities of HK$101m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. With this level of current liabilities, KPa-BM Holdings's ROCE is boosted somewhat.

Our Take On KPa-BM Holdings's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. But note: KPa-BM Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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

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.

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. Thank you for reading.