Today we are going to look at Pak Tak International Limited (HKG:2668) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding 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. 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'.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Pak Tak International:

0.07 = HK$39m ÷ (HK$1.1b - HK$521m) (Based on the trailing twelve months to December 2019.)

Therefore, Pak Tak International has an ROCE of 7.0%.

View our latest analysis for Pak Tak International

Is Pak Tak International's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Pak Tak International's ROCE appears meaningfully below the 9.3% average reported by the Luxury industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Pak Tak International stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

Pak Tak International reported an ROCE of 7.0% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Pak Tak International's past growth compares to other companies.

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, after all, simply a snap shot of a single year. If Pak Tak International is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Pak Tak International'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.

Pak Tak International has total assets of HK$1.1b and current liabilities of HK$521m. Therefore its current liabilities are equivalent to approximately 49% of its total assets. Pak Tak International has a medium level of current liabilities, which would boost its ROCE somewhat.

Our Take On Pak Tak International's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Pak Tak International 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.