Today we'll look at A-Living Services Co., Ltd. (HKG:3319) 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.

Return On Capital Employed (ROCE): What is it?

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. 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.'

So, How Do We Calculate ROCE?

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 A-Living Services:

0.17 = CN¥949m ÷ (CN¥7.3b - CN¥1.7b) (Based on the trailing twelve months to December 2018.)

So, A-Living Services has an ROCE of 17%.

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Is A-Living Services's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that A-Living Services's ROCE is meaningfully better than the 10% 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. Separate from A-Living Services's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for A-Living Services.

How A-Living Services's Current Liabilities Impact 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.