Today we are going to look at Qingling Motors Co., Ltd. (HKG:1122) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. 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 Qingling Motors:

0.03 = CN¥242m ÷ (CN¥11b - CN¥2.7b) (Based on the trailing twelve months to June 2019.)

Therefore, Qingling Motors has an ROCE of 3.0%.

See our latest analysis for Qingling Motors

Is Qingling Motors's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Qingling Motors's ROCE appears to be significantly below the 6.4% average in the Auto industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Qingling Motors's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

Qingling Motors's current ROCE of 3.0% is lower than 3 years ago, when the company reported a 5.2% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Qingling Motors's ROCE compares to its industry. Click to see more on past growth.

It is important to remember that ROCE shows past performance, and is 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. If Qingling Motors is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.