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Today we'll evaluate O-Net Technologies (Group) Limited (HKG:877) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding 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.'

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 O-Net Technologies (Group):

0.13 = HK$288m ÷ (HK$3.2b - HK$948m) (Based on the trailing twelve months to December 2018.)

Therefore, O-Net Technologies (Group) has an ROCE of 13%.

See our latest analysis for O-Net Technologies (Group)

Is O-Net Technologies (Group)'s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, O-Net Technologies (Group)'s ROCE appears to be around the 13% average of the Communications industry. Independently of how O-Net Technologies (Group) compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Our data shows that O-Net Technologies (Group) currently has an ROCE of 13%, compared to its ROCE of 3.8% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How O-Net Technologies (Group)'s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

O-Net Technologies (Group) has total assets of HK$3.2b and current liabilities of HK$948m. As a result, its current liabilities are equal to approximately 29% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On O-Net Technologies (Group)'s ROCE

With that in mind, O-Net Technologies (Group)'s ROCE appears pretty good. Of course you might be able to find a better stock than O-Net Technologies (Group). So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.