Today we'll look at Binhai Investment Company Limited (HKG:2886) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Binhai Investment:

0.093 = HK$352m ÷ (HK$5.9b - HK$2.1b) (Based on the trailing twelve months to June 2019.)

So, Binhai Investment has an ROCE of 9.3%.

See our latest analysis for Binhai Investment

Does Binhai Investment Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Binhai Investment's ROCE is around the 9.3% average reported by the Gas Utilities industry. Setting aside the industry comparison for now, Binhai Investment's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Binhai Investment's current ROCE of 9.3% is lower than its ROCE in the past, which was 12%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Binhai Investment's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Binhai Investment.

Do Binhai Investment's Current Liabilities Skew 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Binhai Investment has total liabilities of HK$2.1b and total assets of HK$5.9b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. Binhai Investment's middling level of current liabilities have the effect of boosting its ROCE a bit.

Our Take On Binhai Investment's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better investment than Binhai Investment. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.