Today we'll evaluate TK Group (Holdings) Limited (HKG:2283) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. 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.

How Do You Calculate Return On Capital Employed?

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 TK Group (Holdings):

0.23 = HK$374m ÷ (HK$2.5b - HK$842m) (Based on the trailing twelve months to June 2019.)

Therefore, TK Group (Holdings) has an ROCE of 23%.

Check out our latest analysis for TK Group (Holdings)

Is TK Group (Holdings)'s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. TK Group (Holdings)'s ROCE appears to be substantially greater than the 11% average in the Machinery 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. Regardless of the industry comparison, in absolute terms, TK Group (Holdings)'s ROCE currently appears to be excellent.

We can see that, TK Group (Holdings) currently has an ROCE of 23%, less than the 31% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how TK Group (Holdings)'s ROCE compares to its industry, and you can click it to see more detail on its past growth.

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. 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 TK Group (Holdings).

How TK Group (Holdings)'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.